Econ 522 – Lecture 16 (March 26 2009)Tuesday, we began tort law with an experiment (DISCUSS)After that, we…- Defined the three elements of a tort under the traditional theoryo harmo causationo breach of duty (not always required)- Defined a strict liability rule as one which assigns liability based only on harm and causation- And a negligence rule as one which requires all three elementso That is, under strict liability, you’re responsible for any damage you doo Under negligence, you’re responsible for any damage you do if you were being careless (if you breached the duty of due care)Today, we move on to an economic model of torts.- Obviously, the more carefully I drive, the less likely I am to hit you- If transaction costs are low, we can negotiate ahead of time, not for my right to hityou, but for how carefully I’ll driveo If it’s efficient for me to drive a little more carefully, and therefore be a little less likely to hit you, we can negotiate that- Obviously, this doesn’t work in practice; too many drivers, and too hard to “commit” to the correct level of care- Instead, what I expect will happen to me in the event I hit you, will affect how carefully I driveo that is, tort law creates incentives, and I will decide on my behavior as a response- As we said earlier, the essence of tort law is to use liability to get injurers to internalize the externalities their behaviors cause.- 1 -Ssuppose there is some type of accident that may or may not happen- I may run into you in my car- A manufacturer may accidentally use lead paint in its toys, etcFor simplicity, we will focus on the case of unilateral harm- that is, there is only one victim- (not the case with car accidents where both parties get hurt)There is also some amount of precaution that can be taken that makes the accident less likely.Let- x denote the level of precaution- w the cost of each incremental unit of precaution (could be money, time, inconvenience)- p(x) the probability an accident occurs, given that level of precautiono so p(x) is decreasing in x – more precaution = fewer accidents- A be the cost of an accidento borne by victimThen the cost of precaution is wx, and the expected cost of accidents is p(x) AWe can graph these against x, the level of precaution:- 2 -precautionp(x) Awx- The total social cost due to this type of accident is the expected cost of accidents, plus the resources spent in prevention:Social Cost = wx + p(x) A- So the efficient level of precaution will be the level of precaution that minimizes this.o (Add social cost to the graph)- Graphically: we’re interested in the lowest point on the curve wx + p(x) Ao where total social costs are minimized- Calculus: to minimize wx + p(x) A, we take the derivative, and find w + p’(x)A = 0or at the efficient level of precaution, x*, w = – p’(x*) A- LHS is marginal social cost of precaution- RHS is marginal social benefit- optimal level sets marginal cost = marginal benefitUnder reasonable assumptions…- When x < x*, -p’(x) A > w; the marginal social benefit of more precaution is bigger than its cost, and so more precaution is better.- When x > x*, -p’(x) A < w; the marginal social benefit of more precaution is less than its cost, and so less precaution would be optimal.- 3 -precautionp(x) Awxwx + p(x)ANote that we haven’t yet specified who is taking this precaution- In many cases, it is mainly the injurer who can take precautions to reduce the likelihood of accidents- In some cases, the victim can also take precautions- The book gives a bunch of examples where both the injurer and the victim has some influence on the likelihood of an accident:Accident Injurer’s precaution Victim’s precautionFaulty electrical wiring causes house fireManufacture wiring more carefullyFireproof the houseMoving car hits parked car Drive more safely Park car in safer locationCar hits pedestrian Drive more safety Walk more safelySoftware fails Better design of software Back up data at risk*Exploding coke bottles Improve quality control Handle bottles carefullyMedicine causes side effects Improve warning label Study warning level/interactions carefully(* This one doesn’t really fit their setup, since it really lowers the cost of each accident, not the probability of an accident occurring)- For now, we will focus on the case of unilateral precautiono that is, just one party is in a position to reduce the likelihood of an accidento (but it could be either party)o Under certain assumptions, what we say will generalize to bilateral precaution – when both parties affect the likelihood of accidentso But the bilateral case is harder, so for now, we’ll stick to unilateral- 4 -Rule 1: No Liability- First, we consider a world without lawsuits, where nobody is liable for any harms that they cause accidentally- Suppose first that it’s the victim who can take actions to prevent the accidento say, a bicyclist who could wear reflective clothing and use a light when riding at night, so he’s more visible to drivers- x is the level of precaution taken by the victim, and p(x) the probability of an accident- If there is no liability, the victim incurs the full cost of the accidents, A- So the victim chooses a precaution level to minimizew x + p(x) Awhich leads him to a level of precaution xv* which solvesw = - p’(x) A(again, LHS is his marginal cost of more precaution, the RHS is his marginal private benefit)- But this is exactly the efficient level of precaution from before- So when it is only the victim who can prevent accidents, a rule of no liability leads to efficiency- This makes sense: since the victim bears the cost of accidents, he gets the full benefit from taking precaution; he also pays the full cost of it; so there is no externality caused by the level of precaution, and he sets it efficiently- 5 -- But on the other hand, suppose it is the injurer whose actions determine how likely accidents areo for example, x can be a measure of how carefully you drive- Under a system of no liability, the injurer doesn’t face any costs from accidents hecauses- So he simply tries to minimize wx- Which means when there is no liability, the injurer has no incentive to take costly precautions, so he sets x = 0, which is lower than the social optimum.So a rule of no liability leads the injurer to select an inefficiently low level of precaution.We can put these two results into a table:Legal Rule Victim’s Precaution Injurer’s PrecautionNo liability
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