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UW-Madison ECON 522 - Lecture Notes

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Econ 522 – Lecture 20 (Nov 15 2007)Tuesday, we considered the effects of relaxing some of the assumptions of our “baseline” model of tort law.The next question is the calculation of damages. Up till now, we’ve been assuming the possibility of perfect compensatory damages, that is, damages that make the victim indifferent between having been in the accident and received damages, and never having been injured in the first place. This accomplishes two things:- First, it returns the victim to their original level of well-being – not so important from an efficiency point of view, but appealing in terms of fairness. (In addition, this means that liability functions like insurance – if we imagine that people are risk-averse, this is a good thing.)- Second, if the “price” of injuring someone matches the actual harm done, the injurer exactly internalizes the externality he’s causing by his actions, leading to correct incentivesIn some instances, compensatory damages like this are not too hard to calculate. If I cause an accident that destroys your car, we can figure out the market price of cars similar to yours. Even if your car is a rare antique, there’s probably some price at which you would have been willing to sell it; figuring out that price might be tricky in practice, but isn’t a big deal conceptually.However, there are some items for which there is nothing approaching a market substitute, and no amount of damages is likely to make someone indifferent. There mightbe no price at which you would be willing to give up an arm or a leg; there is certainly noprice at which most parents would be indifferent toward losing a child.Calculating damages in these cases is a hard problem, and there is no clear guideline for what they should be. Cooter and Ulen cite recommended jury instructions from a couple of states, to point out that juries are not given much of a theoretical framework for calculating the value of a life. From Massachusetts:Recovery for wrongful death represents damages to the survivors for the loss of value of decedent’s life… There is no special formula under the law to assess the plaintiff’s damages… It is your obligation to assess what is fair, adequate, and just. You must use your wisdom and judgment and your sense of basic justice to translate into dollars and cents the amount which will fully, fairly, and reasonably compensate the next of kin for the death of the decedent. You must be guided by your common sense and your conscience on the evidence of the case…From California:Also, you should award reasonable compensation for the loss of love, companionship, comfort, affection, society, solace or moral support.Doesn’t really clear it up all that much.(The book also points out an odd characteristic of compensatory damages. Most people would rather be horribly injured than killed, so killing someone does more damage than injuring someone. However, compensatory damages tend to be lower for a fatal accident than for an accident which cripples someone. This is because when someone is badly injured in an accident, it may require a huge amount of money to compensate them: ongoing medical treatment, pain and suffering, and the change in quality-of-life over the remainder of their life. When someone is killed, they are no longer able to receive compensation, so no attempt is made to compensate them; damages in a wrongful-death case are meant to compensate their loved ones for their loss – lost income the victim’s family would have received over the rest of his working life, and lost companionship. Because no attempt is made to compensate the dead victim, these damages tend to be smaller.)The book points out that, besides courts, there are others who sometimes need to calculate the value of a “statistical life”: regulators. Safety regulators can always save incremental lives by imposing tougher and tougher regulations that will be more and more costly to comply with. Knowing when to stop requires a cost-benefit analysis, which in turn requires some notion of how much saving a life is worth.The Viscusi paper points out that the cost to save an incremental life varies wildly across different types of safety regulation:Airplane cabin fire protection costs $200,000 per life saved; automobile side door protection standards save lives at $1.3 million each; Occupational Safety and Health Administration (OSHA) asbestos regulations save lives at $89.3 million each; Environmental Protection Agency (EPA) asbestos regulations save lives at $104.2 million each; and a proposed OSHA formaldehyde standard cost $72 billion per life saved.Most people won’t have a good answer if you ask them how much money they would demand to allow you to kill them; that is, there’s no amount of money you could give someone to make them indifferent between living and dying. Conceptually, though, part of the problem here is that, once they’re dead, they get no benefit from having the money.It’s entirely possible that there is some amount of money you could give someone to make them willing to take a probabilistic risk of dying. That is, for a given risk of dying p, there could be some amount of money that, enjoyed the rest of the time (when you don’t die), makes that risk of death acceptable:p u(D) + (1-p) u(w + M) = u(w)When p goes to 1, this breaks down not because you can’t equate death with compensation, but because the second term (the times you get to enjoy the compensation)vanishes.So in theory, we could poll a bunch of people and ask how much money they’d demand to take a 1/100 risk of death, or a 1/1000 risk of death, or even a 1/10 risk of death, and see what they said. However, there’s no way to test whether what they’re saying is right. That is, unlike some economic experiments, where we can put a bunch of students in a lab and have them play for actual money, there’s no way to carry out an experiment where we actually intend to deliberately expose people to a risk of death.However, there is a way around this: we can try to impute the compensation people demand for risk from the choices they actually make. There are lots of things we do in day-to-day life that increase or decrease our risk of death: we choose to buy a sports car with a fiberglass body or we buy a Volvo; we take a job washing skyscraper windows, or a job answering phones; we buy smoke detectors and fire extinguishers, or we don’t. If we observe the


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