Economics of Tort Law

Review of Microeconomic Theory

What is a tort?Contract law: injury from a broken promiseTort law: injury without any promises

Intentional tort ( crime) Unintentional tort (accidents)If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer. Focus on efficiency: structure the law to provide the correct incentives to avoid/prevent harm

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Example 1: Joe Potatoes Joe Potatoes has been driven to distraction by the escapades of his wife, Joan Potatoes. At the end of a hard nights work at the loading dock, Joe is approached by Jim Bloggs. Suspecting that Jim has been romancing Joan, Joe insults and strikes him, breaking his nose. Bloggs subsequently sues for the injury to his reputation and his nose.

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Example 2: Pheasant Hunting Three hunters go into the woods after pheasants. They are spread out in a straggling line about 25 yards apart, walking in the same direction. The hunter in the center flushes a bird that flies up, its wings pounding. The hunter to his left and right turn toward the bird in the middle and fire. The bird escapes, but the hunter in the middle is blinded by birdshot. One of the two hunters certainly caused the harm, but there is no way of determining which one of them it was. The victim sues both of them.

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Example 3: Fuel Additives A manufacturer produces auto fuel additives that demand careful control over quality. If quality control is maintained at a high level, the chemical mixture in the product is correct, and it never causes damage to auto engines. If, however, quality control is relaxed and allowed to fall to a low level, some batches of the chemical mixture will be flawed. A few of the cars using the flawed batch will be harmed; specifically, the engine will throw a rod and tear itself to pieces. After the rod is thrown, as alert mechanic can detect the cause of the harm. The manufacturer determines that a high level of control costs more than the harm to some auto engines caused by a low level of quality control, so the manufacturer adopts a low level of quality control. The owner of the damaged car sues the manufacturer and asks for punitive damages.

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Classroom ExperimentVictor Matheson (2005), Rationality, Tort Reform and Contingent Valuation: A Classroom Experiment in Starting Point Bias. College of the Holy Cross Working Paper

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Focal Point Experiment

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Traditional Theory of TortsHarmPerfect compensation?Tangible vs intangible lossesCausationcause-in-fact:but for A, would B have occurred?If NO, then A is the cause-in-fact of BProximate causeBreach of duty (fault)Strict liability: only Harm and Causation matterNegligence: requires Harm, Causation, and Fault

Can you sue for exposure to harm?Does smoking cigarettes cause cancer?

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How do you determine fault?Binary faultContinuous faultnot at fault if x at fault if x < Precaution (x)Legal standard: reasonable person0

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A Trolley FollyA tree fell on a moving trolley, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolley to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip. Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe. If he had not driven over the speed limit, the trolley would not have been under the tree when it fell, so, the plaintiff argued, the drivers negligence caused the injury.The court held that the drivers negligence had not caused the accident in the legally relevant sense.

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A Model of Optimal PrecautionSocial Objective: minimize social costs of accidentsPrecaution costsAccident lossesAdministrative costs

AssumptionsRationalityLitigation is costlessNo insurance availableNo safety regulation

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A Model of Optimal PrecautionDefine:x = level of precaution by injurerp(x) = probability of accident [p(x) < 0]A = victims accident lossesw = cost per unit of precaution

Social Costs = wx + p(x)AWhat level of x will minimize Social Costs?

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A Model of Optimal PrecautionPrecaution (x)$wxp(x)ASocial Costs = wx + p(x)ASCx* occurs where: w = -p(x)Ax*MC of precaution = MB of precaution

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Examples of Accidents and Precaution

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Incentives for PrecautionTort liability gets injurer to internalize the harm they cause victims

3 Liability RulesNo LiabilityStrict LiabilityNegligence rule

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No LiabilityVictims IncentivesVictim bears full cost of accidentVictims cost = wvxv + p(xv)A

Injurers IncentivesInjurer faces no liabilityInjurers cost = wixi Choose xv* Choose xi = 0

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Strict LiabilityVictims IncentivesVictim receives damages of DVictims cost = wvxv + p(xv)[A-D]Victims cost = wvxv (if D = A)

Injurers IncentivesInjurers cost = wixi + p(xi)D Choose xv = 0 Choose xi*

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No Liability vs Strict LiabilityUnilateral precaution situations:When only victim can take precaution, NL is preferableWhen only injurer can take precaution, SL is preferable

Bilateral precaution situations?Analogous to contract law where we should allocate risk to the low-cost avoider.

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Simple Negligence RuleInjurers Incentives if x < then D = A

Injurers cost = wixi + p(xi)D

if x then D = 0

Injurers cost = wixi

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Simple Negligence RulePrecaution (x)$wx= x*wx + p(x)AInjurer will choose xi*What will victim do?

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Contributory NegligenceNegligent injurer can escape liability if victim was also negligent

Victim has incentive to choose xv*Injurer has incentive to choose xi*

Im talking on my cell phone while driving, but drunk pedestrian stumbles into roadSince injurer expects victim to take efficient precaution, injurer will minimize costs by being careful

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Comparative NegligenceIf both parties are negligent, they share the responsibilityInjurer has incentive to choose xi*Victim has incentive to choose xv*

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Liability Rule SummaryWarning: Activity levels also affect the likelihood of an accident

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Efficient Precaution and ActivityWho bears residual risk?

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Setting the Standard: The Hand RuleUnited States v Carroll Towing Company (1947)

Hand Rule: if w < -pA then injurer is negligent

Have all cost-justified precautions been taken?

Case-by-case basisRegulations Social customsSince there are occasions when every vessel will break from her moorings, and since, if she does, she becomes a menace to those about her; the owners duty, as in other similar situations, to provide against resulting injuries is a function of three variables: (1) The probability that she will break away; (2) the gravity of the resulting injury, if she does; (3) the burden of adequate precautions. Possibly it serves to bring this notion into relief to state it in algebraic terms: if the probability be called P; the injury, L; and the burden, B; liability depends upon whether B is less than L multiplied by P: i.e., whether B < PL. Judge Learned Hand

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Errors in Damage AwardsRandom mistakesSystematic mistakes

Strict LiabilityRandom mistakes: no effect on precautionSystematic mistakes: xi varies directly with errorNegligence RuleModest damage errors will not affect xixi varies directly with errors in setting the legal standard

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Administrative CostsSocial Cost = wx + p(x)A + C

No Liability: saves on C but erodes incentive for precaution

Strict Liability: requires harm and causeLeads to more cases, but easier cases

Negligence: requires harm, cause, and faultLeads to fewer cases, but costlier cases

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Exploding Pop BottleWhen consumers have perfect information, the choice of liability rule is irrelevant; every rule generates efficient precaution and output Strict Liability is a substitute for perfect consumer information

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Residual risk bearer will choose an efficient activity level.See handout from class.