Econ 522 – Lecture 17 (Nov 11 2008)HW 3 posted online – due Thursday after Thanksgivingmidterm graded – will return end of lectureLast week, we introduced a model of unilateral precaution, and looked at the effect various liability rules have on both injurer and victim behavior.In particular, we found that:- a rule of no liability leads to inefficiently low injurer precaution, as well as inefficiently high injurer activity, since he does not internalize the cost of accidents; but it leads to efficient behavior by victims, since they face the full costof accidents- a rule of strict liability leads to efficient behavior by injurers, since they bear the cost of accidents; but it leads to inefficiently low victim precaution, and inefficiently high victim activity, since they are fully compensated for accidents and therefore do not consider their costs- a negligence rule, with the correct standard of care, can achieve the efficient level of precaution by either victim or injurer- under a negligence rule, one party or the other remains the residual risk bearer (that is, pays the cost of any accidents that still occur despite efficient precaution);this party sets an efficient activity level, while the other party still sets an inefficiently high level of activityThe Shavell paper, “Strict Liability versus Negligence,” calls the cases we’ve been looking at “accidents between strangers”. That is, when a car hits a bicyclist, there is no preexisting relationship between the two parties. However, Shavell also looks at caseswhere the injurer is a business, engaged in selling some product (either to the victim or tosomeone else). Under the assumption of competitive markets, this changes the story significantly.Shavell assumes it is only injurer precaution that affects the likelihood of accidents. He looks at a number of different cases. (Under injurer precaution, a rule of no liability is obviously bad, so he focus on comparing negligence to strict liability.) He assumes there is no insurance.- First, as we’ve already seen, is the case of accidents between strangers – or as he puts it, “injurers and victims are strangers, neither are sellers of a product, and injurers may choose to engage in an activity which puts victims at risk”- He gives a nice explanation of what happens under a simple negligence rule:- “Under the negligence rule, all that an injurer needs to do to avoid the possibility of liability is to make sure to exercise due care if he engages in his activity. Consequently he will not be motivated to consider the effect on accident losses of his choice of whether to engage in his activity or, more generally, of the level at which to engage in his activity; he will choose his level of activity in accordance only with the personal benefits so derived. But surely any increase in his level of activity will typically raise expected accident losses. Thus he will be led to choose too high a level of activity.”- Under a strict liability rule, on the other hand: “Because an injurer must pay for losses whenever he is involved in an accident, he will be induced to consider the effect on accident losses of both his level of care and his level of activity. His decisions will therefore be efficient. Because drivers will be liable for losses sustained by pedestrians, they will decide not only to exercise due care in driving but also to drive only when the utility gained from it outweighs expected liability payments to pedestrians.”- We can start our table again, focusing only on injurer precaution and injurer activity:ACCIDENTS BETWEEN STRANGERSLiability Rule Seller Precaution Seller ActivitySimple Negligence Efficient Too HighStrict Liability Efficient Efficient- Next, Shavell considers accidents between sellers and strangers – that is, injurers are engaged in some sort of competitive business, but not with their victims- He gives the example of taxi drivers – taxis provide a service to passengers, but still run the risk of hitting other pedestrians who aren’t their passengers- Shavell assumes that there is perfect competition – taxis lower their prices to compete against each other, up till prices equal the costs of “production”; and the number of passengers who demand rides at those prices determine the level of sales- Under a strict liability rule, the outcome is still efficient, but for a different reason- Under strict liability, taxi drivers pay for accidents, so they will take the efficient level of precaution- In addition, the expected costs of remaining accidents is borne by the taxi drivers, so under competition, it is built into the price of a taxi ride- (That is, once taxi fares reach the level that just covers costs plus expected damage payments, taxi drivers stop lowering prices, so that sets the price.)- This means that taxi passengers face the “socially optimal” price – given efficient precaution, they now internalize the cost of accidents, so they take the efficient number of taxi rides- Under a negligence rule, the activity level is still inefficiently high, but again, for a different reason- Under a negligence rule, taxi drivers take efficient precaution, to avoid liability for any accidents that occur- But once they’re taking efficient precaution, they’re no longer liable, so they do not bear the costs of accidents- So the cost of accidents is not built into prices- So passengers face prices that are too low – taxi passengers don’t internalize the cost of accidents when they decide how often to ride- So the demand for taxi rides will be inefficiently high – again, we get an inefficiently high activity level- So the table looks the same as before:Liability Rule Seller Precaution Seller ActivityACCIDENTS BETWEEN STRANGERSSimple Negligence Efficient Too HighStrict Liability Efficient EfficientACCIDENTS BETWEEN SELLERS AND STRANGERSSimple Negligence Efficient Too HighStrict Liability Efficient Efficient- The third case that Shavell considers is that of accidents between sellers and their customers (or their employees)- Here, he uses the example of restaurants taking precautions to reduce the risk of food poisoning- In this case, it ends up vitally important how accurately customers perceive risks- He looks at three separate cases:o customers can accurately perceive the risk of each restauranto customers can accurately perceive the average level of risk, but not differences between different restaurantso
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