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Econ 522 Economics of LawMonday…Model of unilateral harmSlide 3Effect of liability rules on precautionRule 1: No LiabilitySlide 7Slide 8Rule 2: Strict LiabilitySlide 10Slide 11So for accidents with unilateral precaution…Rule 3: “Simple Negligence”Rule 3: Simple Negligence Injurer precautionRule 3: Simple Negligence Victim precautionSlide 16In fact, there are several ways we could implement a negligence ruleThe cool part…Discrete example of bilateral precautionDifferent negligence rulesNegligence with a Defense of Contributory NegligenceSlide 22Comparative NegligenceSlide 24Strict Liability with a Defense of Contributory NegligenceSo with bilateral precaution…(Aside: with bilateral precaution, things occasionally get more complicated…)So far, our results seem to favor negligence rules…Slide 28Activity levelsActivity levels under a rule of no liabilityAdding activity levels to our results on precaution…Activity levels under a rule of strict liabilitySlide 34What about activity levels under negligence rules?Slide 36Negligence with Defense of Contributory Negligence, and Comparative NegligenceSlide 38Strict Liability with Defense of Contributory NegligenceSlide 40Slide 41Slide 42With each negligence rule…So which rule is best?Friedman: activity is just unobservable precautionSlide 45Steven Shavell, Strict Liability Versus NegligenceSlide 48Slide 49Next case: accidents between “sellers and strangers”Accidents between businesses and strangersSlide 52Final case: accidents between businesses and their own customersAccidents between businesses and their own customers: strict liabilityAccidents between businesses and their own customersAccidents between businesses and their own customers: negligenceSlide 57Accidents between businesses and their own customers: no liabilitySlide 59Next few lectures…Econ 522Economics of LawDan QuintFall 2011Lecture 162Elements of a tortHarm; causation; breach of duty (negligence)Strict liability rule: need to prove harm and causationNegligence rule: need to prove all three elementsPrecaution: any actions taken to reduce likelihood of an accidentBegan to set up simple model to evaluate liability rulesunilateral harm; no insurance; both parties know lawMonday…3Model of unilateral harmx level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accidentPrecaution (x)$p(x) A (Cost of Accidents)wx (Cost of Precaution)wx + p(x) A(Total Social Cost)x* (Efficient Level of Precaution)4Effect of Liability Ruleson Precaution5Already know what’s efficientLevel of precaution that minimizes total social cost = wx + p(x) AWe’ll consider what happens if there is…no liability rule in placea strict liability rulea negligence ruleEffect of liability rules on precaution6In a world with no liability…Injurer does not have to pay for accidentsSo, bears cost of any precautions he takes, but does not receive any benefitInjurer has no incentive to take precautionVictim bears cost of any accidents, plus cost of precaution he takes(Victim precaution imposes no externality on injurer)Victim precaution will be efficientRule 1: No Liability7Injurer’s private costis just wxMinimized at x = 0Victim’s private costis p(x) A + wxMinimized at efficientprecaution level x = x*So rule of no liability leads to efficient precaution by victims, no precaution by injurersRule 1: No Liabilityx$p(x) Awxwx + p(x) Ax*Private cost to injurerPrivate cost to victim8So in a world with no liability…Injurer takes inefficiently low level of precaution(zero, or minimal amount)Victim takes efficient amount of precautionRule 1: No Liability9Perfect compensation: damages D = AUnder strict liability…Injurer pays damages for any accidents he causesSo injurer bears cost of accidents, plus his own precautionInjurer internalizes externality his actions cause  chooses efficientlyVictim is fully insured, no incentive for precautionRule 2: Strict Liability10(Damages = A)Injurer’s private costis p(x) A + wxMinimized at efficientprecaution level x = x*Victim’s private costis just wxMinimized at x = 0So rule of strict liability leads to efficient precaution by injurers, no precaution by victimsRule 2: Strict Liabilityx$p(x) Awxwx + p(x) Ax*Private cost to injurerPrivate cost to victim11Effect of liability rules on precautionEfficientZeroStrict LiabilityZeroEfficientNo LiabilityInjurerprecautionVictimprecaution12When it’s the injurer who can take precautions, a rule of strict liability is more efficientWhen it’s the victim who can take precautions, a rule of no liability is more efficientEach rule works well for one incentive, poorly for otherSimilar to paradox of compensation we saw in contract lawNegligence rule may allow us to get both incentives rightSo for accidents with unilateral precaution…13Legal standard of care xnInjurer is liable for damages if precaution level was below the legal standard of carex < xn  D = Ax  xn  D = 0So on our graph from before, private cost to injurer is…wx + p(x) A for x < xnwx for x  xnSince we’re shooting for efficiency, we’ll suppose xn = x*Rule 3: “Simple Negligence”14Rule 3: Simple NegligenceInjurer precautionx$p(x) Awxwx + p(x) Axn = x*Private cost is wx + p(x) A if x < xn, only wx otherwiseIf standard of care is set efficiently (xn = x*), injurer minimizes private cost by taking efficient precautionPrivate cost to injurer15Rule 3: Simple NegligenceVictim precaution$p(x) Awxwx + p(x) Ax*What about victim?We just said, injurer will take efficient precautionWhich means injurer will not be liableSo victim bears costs of any accidents(Victim bears residual risk)So victim’s private cost is wx + p(x) AVictim minimizes private cost by taking efficient level of precaution too!Private cost to victim(assuming injurer takes efficient level of precaution and is therefore not liable for damages)16Effect of liability rules on precautionEfficientEfficientSimple Negligence,with xn = x*EfficientZeroStrict LiabilityZeroEfficientNo LiabilityInjurerprecautionVictimprecaution17Rule we just saw: injurer is liable if he was negligent, not liable if he wasn’t“Simple Negligence”Doesn’t consider whether victim was negligent, only injurerBut we can consider both


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UW-Madison ECON 522 - Lecture 16 Notes

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