Economics of Tort Law

What is a tort? Contract law: injury from a broken promise Tort 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

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 night’s 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.

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.

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.

Classroom Experiment Victor Matheson (2005), “Rationality, Tort Reform and

Contingent Valuation: A Classroom Experiment in Starting Point Bias.” College of the Holy Cross Working Paper

Focal Point ExperimentReference Point $10,000 $1,000,000

Smallest Damages $100,000 $500,000

Largest Damages $1,000,000 $2,000,000

Median Damages $500,000 $650,000

$1m or less 5 out of 6 4 out of 6

Traditional Theory of Torts Harm

Perfect compensation? Tangible vs intangible losses

Causation “cause-in-fact”:but for A, would B have occurred?

If NO, then A is the cause-in-fact of B Proximate cause

Breach of duty (fault) Strict liability: only Harm and Causation matter Negligence: requires Harm, Causation, and Fault

Can you sue for exposure to harm?

Does smoking cigarettes cause cancer?

How do you determine fault? Binary fault Continuous fault

not at fault if x ≥ at fault if x <

x~Precaution (x)

Legal standard: reasonable person

x~

x~

Not at faultNegligent

0

A Trolley Folly“A 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 driver’s negligence caused the injury.”

The court held that the driver’s negligence “had not caused the accident in the legally relevant sense.”

A Model of Optimal Precaution Social Objective: minimize social costs of accidents

Precaution costs Accident losses Administrative costs

Assumptions Rationality Litigation is costless No insurance available No safety regulation

Define: x = level of precaution by injurer p(x) = probability of accident [p’(x) < 0] A = victim’s accident losses w = cost per unit of precaution

A Model of Optimal Precaution

Social Costs = wx + p(x)A

What level of x will minimize Social Costs?

A Model of Optimal Precaution

Precaution (x)

$

wx

p(x)A

Social Costs = wx + p(x)A

SC

x* occurs where: w = -p’(x)A

x*

MC of precaution = MB of precaution

Examples of Accidents and Precaution

Accident Injurer’s precaution Victim’s precaution

Faulty wiring causes house fire

Manufacture wiring more carefully

Fireproof the house

Moving car hits parked car

Drive more safely Park car in safer location

Car hits pedestrian Drive more safety Walk more safely

Software fails Better design of software

Back up data at risk

Exploding pop bottle Improve quality control Handle bottles carefully

Medicine causes side effects

Improve warning label Study warning on medicine

Incentives for Precaution Tort liability gets injurer to internalize the

harm they cause victims

3 Liability Rules No Liability Strict Liability Negligence rule

No Liability Victim’s Incentives

Victim bears full cost of accident Victim’s cost = wvxv + p(xv)A

Injurer’s Incentives Injurer faces no liability Injurer’s cost = wixi

Choose xv*

Choose xi = 0

Strict Liability Victim’s Incentives

Victim receives damages of D Victim’s cost = wvxv + p(xv)[A-D]

Victim’s cost = wvxv (if D = A)

Injurer’s Incentives Injurer’s cost = wixi + p(xi)D

Choose xv = 0

Choose xi*

Perfect compensation

No Liability vs Strict Liability

Unilateral precaution situations: When only victim can take precaution, NL is preferable When only injurer can take precaution, SL is preferable

Bilateral precaution situations?

Legal Rule Victim’s Precaution Injurer’s Precaution

No liability Efficient Zero

Strict liability Zero Efficient

Analogous to contract law where we should allocate risk to the low-cost avoider.

Simple Negligence Rule Injurer’s Incentives

if x < then D = A

Injurer’s cost = wixi + p(xi)D

if x ≥ then D = 0

Injurer’s cost = wixi

x~

x~

Simple Negligence Rule

Precaution (x)

$

wx

= x*

wx + p(x)A

x~

Injurer will choose xi*

What will victim do?

Contributory Negligence Negligent injurer can escape liability if

victim was also negligent

Victim has incentive to choose xv*

Injurer has incentive to choose xi*

I’m talking on my cell phone while driving, but drunk pedestrian stumbles into road

Since injurer expects victim to take efficient precaution, injurer will minimize costs by being careful

Comparative Negligence If both parties are negligent, they share

the responsibility Injurer has incentive to choose xi*

Victim has incentive to choose xv*

Liability Rule Summary

Legal RuleVictim’s

PrecautionInjurer’s

Precaution

No liability Efficient Zero

Strict liability Zero Efficient

“Any” negligence rule with efficient standards of care

Efficient Efficient

Warning: Activity levels also affect the likelihood of an accident

Legal Rule Victim Precaution

Injurer Precaution

Victim Activity

Injurer Activity

No Liability Efficient Zero Efficient Too High

Strict Liability Zero Efficient Too High Efficient

Simple Negligence

Efficient Efficient Efficient Too High

Contributory Negligence

Efficient Efficient Efficient Too High

Comparative Negligence

Efficient Efficient Efficient Too High

Strict Liability with CN

Efficient Efficient Too High Efficient

Efficient Precaution and Activity

Who bears “residual risk”?

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

Hand Rule: if w < -p’A then injurer is negligent

Have all cost-justified precautions been taken?

Case-by-case basis Regulations Social customs

Since 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 owner’s 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

Errors in Damage Awards Random mistakes Systematic mistakes

Strict Liability Random mistakes: no effect on precaution Systematic mistakes: xi varies directly with error

Negligence Rule Modest damage errors will not affect xi

xi varies directly with errors in setting the legal standard

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

No Liability: saves on C but erodes incentive for precaution

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

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

Exploding Pop BottleBehavior of Firm

Firm’s Cost of Production per unit

Probability of Accident to Consumer

Loss if Accident

Expected Accident Loss

Full Cost per unit

Use Bottle 40 cents 1/100,000 $10,000 10 cents 50 cents

Use Can 43 cents 1/200,000 $4,000 2 cents 45 cents

When 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