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Economics of

Tort Law

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

If someone shoots you, you call a cop. If he


runs his car into yours, you call a lawyer.

Intentional tort
( crime)
Unintentional tort (accidents)
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 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.

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 Experiment


Reference 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

Does smoking cigarettes cause cancer?

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

Can you sue for exposure to harm?

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

How do you determine


fault?

Binary fault
Continuous fault

not at fault if x
~
at fault if x < x

~
x
Not at fault

Negligent

Precaution (x)

~
x
Legal standard: reasonable person

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 drivers
negligence caused the injury.
The court held that the drivers 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

A Model of Optimal
Precaution

Define:

x = level of precaution by injurer


p(x) = probability of accident [p(x) < 0]
A = victims accident losses
w = cost per unit of precaution

Social Costs = wx + p(x)A


What level of x will minimize Social Costs?

A Model of Optimal
Precaution
$

Social Costs = wx + p(x)A

SC
wx

p(x)A
x*

x* occurs where:

Precaution (x)

w = -p(x)A

MC of precaution = MB of precaution

Examples of Accidents and


Precaution
Accident

Injurers precaution

Victims 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

Victims Incentives

Victim bears full cost of accident


Victims cost = wvxv + p(xv)A

Choose xv*

Injurers Incentives

Injurer faces no liability


Choose xi = 0
Injurers cost = wixi

Strict Liability

Victims Incentives

Victim receives damages of D


Victims cost = wvxv + p(xv)[A-D]

Victims cost = wvxv (if D = A)

Choose xv = 0

Perfect compensation

Injurers Incentives

Injurers cost = wixi + p(xi)D

Choose xi*

No Liability vs Strict
Liability
Legal Rule

Victims Precaution

Injurers Precaution

No liability

Efficient

Zero

Zero

Efficient

Strict liability

Unilateral precaution situations:

When only victim can take precaution, NL is preferable


When only injurer can take precaution, SL is preferable

Analogous to contract law where we should


Bilateral
precaution
situations?
allocate
risk to the low-cost
avoider.

Simple Negligence Rule

Injurers Incentives
if x < ~
x then D = A
Injurers cost = wixi + p(xi)D

~
if x x

then D = 0

Injurers cost = wixi

Simple Negligence Rule


$

wx + p(x)A
wx

~
x

= x*

Injurer will choose xi*


What will victim do?

Precaution (x)

Contributory Negligence

Negligent injurer can escape liability if


victim was also negligent
Im talking on my cell phone while driving,
but drunk pedestrian stumbles into road

Victim has incentive to choose xv*

Injurer has incentive to choose xi*


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 Rule

Victims
Precaution

Injurers
Precaution

No liability

Efficient

Zero

Zero

Efficient

Efficient

Efficient

Strict liability
Any negligence rule with
efficient standards of care

Warning: Activity levels also affect the likelihood of an accident

Who bears residual risk?

Efficient Precaution and


Activity

Legal Rule

Victim
Precaution

Injurer
Precaution

Victim
Activity

Injurer
Activity

No Liability

Efficient

Zero

Efficient

Too High

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

Strict Liability

Setting the Standard: The


Hand Rule

United States v Carroll Towing Company (1947)

Since
there
are occasions
when every
will is
break
from her
Hand
Rule:
if w < -pA
thenvessel
injurer
negligent

moorings, and since, if she does, she becomes a menace to those


about her; the owners duty, as in other similar situations, to
Have
all resulting
cost-justified
precautions
taken?
provide
against
injuries
is a functionbeen
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
Case-by-case basis
precautions. Possibly it serves to bring this notion into relief to
algebraic
Regulations
state it in
terms: if the probability be called P; the
injury, L; and
the customs
burden, B; liability depends upon whether B is
Social
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 Costs
Social 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 Bottle


Behavior
of Firm

Firms
Cost of
Production
per unit

Probability
Loss if
of Accident
Accident
to Consumer

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