Courts and the Tort-Contract Boundary in Product Liability

Paul H. Rubin*

Emory University Department of Economics

Forthcoming in Frank Buckley, editor, The Fall and Rise of Freedom ofContract, Duke University Press, 1999.

In this Article I address the appropriate source of liability in cases ofinjury between parties with a pre-injury contractual relationship. This applies toproduct liability (for direct purchasers, not for injured third parties) and also tomedical malpractice.1 Since the parties do have a pre-injury relationship, theycould contract ex ante for damages and liability standards through warrantiesand disclaimers; if they did so, then they would probably choose standards sothat many fewer cases would be filed. The current legal system, behavingconsistently with arguments made by Atiyah and Gilmore,2 instead treats theseinjuries as torts and handles them through product liability, leading to manyadditional cases. This means that consumers and producers are forced to acceptthe terms imposed by the courts, and there is no room for variation. Theliterature arguing for contractual treatments of such injuries is voluminous3 as isthe literature arguing for the now traditional treatment as a tort, a very smallsample of which is discussed below.

I first address the importance of the issue: Why does it matter if productinjuries are treated as torts or contractual violations? In order to understand theissue, I speculate about the form of tort recovery that consumers would choosein a world of free contract. I then show how this is related to decisionsconsumers make about contracts and to court decisions in the event of injury.Under sufficiently Coasian assumptions about rationality, the way in which wetreat product injuries does not matter. Whether we treat product liability as acontract or a tort issue matters only if some standard assumptions regardingrationality and decision making are violated by either consumers in enteringcontracts or by juries in deciding cases. Thus, the issue of the importance of thelegal regime turns on the nature of the situations in which rationalityassumptions of various sorts are satisfied or violated.

The literature so far has looked at one side of this issue: the extent towhich consumers as parties to contracts violate rationality assumptions andmake agreements that are not in their true interests. This literature has appliedsome of the results of the analysis of cognitive decision making to consumers inthe process of making contracts, and has purported to show that consumers willmake erroneous decisions, or can be manipulated into making such decisions,and thus that they will enter into contracts that do not provide sufficient netbenefits. I show that this set of arguments is flawed, and that the conclusions

Rubin: Tort-Contract Boundary Page 2reached (that intervention into contractual freedom are warranted) areindefensible, at least on this basis. Second, and more importantly, I show thatthis literature itself commits a version of the “Nirvana” fallacy. This is thefallacy of comparing the actual operation of one decision system with the idealoperation of another. Traditionally, the error is comparing actual markets withideal regulation, as pointed out by Coase. Here, it is comparing actual contractswith hypothetical ideal tort liability. I show to the contrary that the sameassumptions regarding cognitive errors and biases that lead some to advocateincreases in intervention with contracts actually cut the other way: if we believethat consumers will make errors in accepting contracts, then courts in productliability cases will make even more severe errors than will consumers incontractual situations, so that if we believe in the importance of cognitiveerrors, then we should be even more in favor of contracts rather than torts.4

I. What Law Would Consumers Want?5

If we replaced tort with contract in those circumstances where partiesare in bargaining or contractual relationships, then producers and consumerswould be able to devise an efficient system, as is true in any other free market.Thus, any attempt here to define an efficient system is in one sense redundantand at a minimum speculative. However, it is possible to conjecture about theterms that might evolve in such a market, as long as we remember that we arespeculating. If the system were allowed to develop freely, then the terms thatwould actually arise would be the desirable terms, and if these terms differ fromthose that I hypothesize to be efficient, this merely means that my speculation isincorrect. The problems with the current tort system stem from the willingnessof outsiders to impose terms on transactors that the outsiders believe areoptimal; I have no such goals.

Since parties are in a pre-accident contractual relationship with eachother, the potential victim is paying money to the potential injurer. If tort lawimposes costs on the injurer, then these costs will ultimately be borne by victimsthrough higher prices. Once parties to contracts learn that the courts willimpose payments in the form of accident compensation, then the expected costof this compensation will be included in the price of the product. It is thispayment that creates the incentive for consumers (who are also potentialvictims) to desire efficient tort standards.

Tort law is commonly viewed as performing two functions. Plaintiff tortlawyers in arguing before juries commonly stress the compensation function:Injurers should pay to compensate their victims. (This view is commonlyrejected by economists.) The other function, generally accepted by economists,is deterrence. Requiring injurers to pay for the cost of injuries they cause willdeter them from causing inefficient future harms.

But while tort law may perform these functions, so do other institutionsin society. Tort law need not bear the entire burden of either compensation orof deterrence. Consider first insurance as a form of compensation. Most

Rubin: Tort-Contract Boundary Page 3consumers have direct medical insurance and loss of wages insurance tocompensate for the cost of injuries, and life insurance to compensate heirs forlost contributions to the family. Thus, tort law does not provide any neededinsurance. Moreover, tortious events, even in today’s litigious world, are rare.Most deaths and injuries occur in ways that do not generate tort liability.Therefore, consumers desiring life, health, disability, or accident insurancewould not be well advised to forgo first party insurance and rely on the chancethat they could collect in court for any injury suffered. Additionally, the cost ofoperating the tort system is about 50%; that is, of every dollar that passesthrough the system $.50 is taken by transactions costs, including legal fees (forboth plaintiffs and defendants, as they are both ultimately paid by consumers)and court costs. This is an extraordinary level of costs – much higher than theoperating cost of any other form of insurance. Indeed, it is so high that aconsumer would have to be exceedingly risk averse to find insurance with thislevel of load worth purchasing. Thus, tort law is a highly inefficient method ofcompensating victims of accidents. For this reason, most students of law andeconomics (including Landes and Posner6 and Shavell7, who are more favorableto the current tort system than many others) believe that the compensationfunction of tort law is relatively unimportant.

Tort law provides a deterrent, but so do other forces. The mostimportant such force is reputation. Firms invest large sums in establishing andprotecting reputations, and there are numerous institutions in the marketplacepolicing and providing information about reputations.8 There is a down side toreputation as well: When a firm does something causing injury to consumers, itsuffers a large loss in the value of its reputation.9 When a product of a firmcauses an injury or is judged unsafe, the company suffers substantial losses instock value, indicating that the stock market anticipates that consumers will bereluctant to purchase the products of that firm.10 Firms, being aware of thesecosts, obviously have very strong incentives, independently of tort law, toprovide safe products.

An additional source for safety in the contemporary U.S. economy isregulation. Virtually all products that might be involved in injuries are regulatedby the Federal Government, through such agencies as the FDA, the CPSC,NHTSA, and others. I am not claiming that such regulation is desirable orefficient, but it does exist. Moreover, when regulation errs, it is often on theside of excessive safety (as shown in the large literature on new drug approvalsby the FDA). If there were less regulation, then we would expect newinstitutions to evolve to provide additional information about product safety toconsumers. Indeed, an important function of safety regulation may be theprovision of information, as when the market reacts to a recall or otherregulatory event indicating insufficient attention to safety by a firm.

Thus, in evaluating tort law, we must remember that it operates inconcert with other forces to provide safety and to compensate injured parties.Economic analyses such as those of Shavell and Landes and Posner that assume

Rubin: Tort-Contract Boundary Page 4that the tort system is the only factor leading to safety therefore overstate theimportance of this system, and the conditions they derive for efficient levels ofsafety are stronger than needed. Indeed, an alternative model to theirs wouldassume that consumers are fully informed about product safety, so that the tortsystem would have no role in increasing safety. The truth is somewhere inbetween.

One caveat is in order. It is not possible or useful to go back to 1960and observe the standards of liability in place then, before the great expansion inliability, to infer what would occur now. From 1959 to 1996, per capita realdisposal personal income more than doubled (from $8638 to $19,242 in 1992dollars11) and, as Aaron Wildavsky12 has told us “Richer is Safer.” Thus,consumers today might demand greater safety than in the past, and this wouldimply different liability rules. Ramseyer describes a voluntary, contractual andapparently successful products liability system that existed until recently inJapan.13

In considering the likely outcome of a regime of free contract, it isimportant to keep in mind the role of competition. For any product, there willbe numerous sellers, and sellers will be able to compete in offering differentcontractual terms. In analyzing contractual “failures,” opponents of freecontract often appear to believe that there is only one seller offering onecontract, and that consumers are at a disadvantage because they cannot bargainwith sellers over the forms of contracts, but are faced with a “take-it-or-leave-it” choice. But if they were allowed to, different sellers would offer differentcontracts, and consumers would then have a choice. Just as sellers compete onprice and other terms of sale, so they can be expected to compete in offeringdifferent contractual terms and warranties as well. Just as the seller who offersthe combination of product quality and price that the consumer most values willsucceed, so the seller who offers the most valuable contractual terms will alsosucceed. The power of consumers comes not from face to face bargaining, butfrom competition in the market. Since lawyers are professionally involved in theformer but not the latter, they tend to underestimate its power. As we will seebelow, this competition is lacking when courts write identical contracts foreveryone.

With these issues in mind, it will be useful to speculate about theefficient form of law. It is helpful to separate the standard of liability from thelevel of damages. I discuss each.

A. Liability StandardsOne issue in analyzing liability much stressed by economists is the

distinction between strict liability and negligence.14 Under strict liability, theinjurer is liable for any harms, no matter what efforts he has made to prevent theharms. Under negligence, the injurer is liable only if he did not take the properamount of care to prevent the accident. Standards may also differ with respectto the obligation of the victim. In a regime of contributory negligence, any

Rubin: Tort-Contract Boundary Page 5contribution made by the victim to causing the accident (for example, byproduct misuse) will release the injurer from liability. In a regime ofcomparative negligence (which is common in the United States today15) thevictim is compensated in proportion to the fraction of the accident caused bythe injurer. Tort analysts find it useful to distinguish between manufacturingdefects and design defects. A manufacturing defect occurs when a particularproduct does not meet its own advertised specifications. If, for example, thesteering wheel in a new car should break during normal driving, this is amanufacturing defect. Many analysts agree that strict liability for manufacturingdefects may be appropriate. Under a strict liability standard, the manufacturer isliable for harm associated with the defect. Such defects are relatively rare andtherefore do not lead to great costs. They are also independent--finding onedefect does not generally mean that an entire product line is flawed. (If amanufacturing defect is common, a product recall can often provide a fix.)There is nothing a consumer can do to avoid these defects since they occur inthe manufacturing process and manufacturers decide how much to spend oninspection and quality control. Costs of determining that a fault has occurredare relatively small. Thus, a strict liability standard for this class of error mightevolve in a free market. Indeed, there is evidence that the original proponentsof strict liability for injuries caused by products had exactly this class of defectsin mind.16

Design defects are quite different. These are said to occur when thecourts rule that it would have been possible for the manufacturer to design theproduct differently and so make it safer. For example, a court may decide thatan automobile manufacturer should have put the gas tank in a different location.If there is a design defect, then all units of some product are defective, since allshare the same design. Viscusi has shown that part of the great expansion inproduct liability occurred when the courts extended strict liability frommanufacturing defects to design defects.17 This theory of liability requires courtsand juries to second guess product designers and determine if there was a saferalternative available when the product was manufactured. Plaintiffs claim thatsuch an alternative was available; defendants claim not. This leads to complexdebates involving engineering and other experts on both sides. Such secondguessing is difficult or impossible, so litigation of such issues is very expensive.Many of the major problems identified with the current tort system are due tothe extension of strict liability to design defects. It is likely that a contractualsolution would lead to little or no liability for design defects, and thus fewercases filed. Moreover, the cases that would not be filed are the most expensiveand difficult, so there would be a great saving from eliminating them.

Another major class of modern liability cases involves a “failure towarn.” Originally it was thought that product warnings would insulatemanufacturers from liability. However, the opposite has occurred:manufacturers are often found liable for failure to warn, sometimes incircumstances where consumers have misused the product in dangerous and

Rubin: Tort-Contract Boundary Page 6unpredictable ways.18 Viscusi indicates that this expansion in liability for failureto warn is the second major cause of the growth in tort liability in thecontemporary U.S. legal system. I would suspect that some liability for failureto warn would remain, but only for risks that were reasonably predictable butnot obvious in normal uses of the product. Liability might also attach to failureto indicate precautions that would avoid injury in such normal use. Again, theresult would be fewer cases.

B. Damage PaymentsIt is useful to divide damage payments into three classes. Pecuniary

damages compensate consumers for actual out of pocket expenses. The majorcategories are medical expenses and lost wages. Nonpecuniary damagescompensate consumers for other, non-money losses. The most important classof nonpecuniary payments are for pain and suffering. Payments for hedoniclosses, or lost pleasure of life, a relatively new and controversial class ofpayments in the tort system, are also nonpecuniary payments.19 Punitivedamages should be for extremely reckless or grossly negligent behavior, wherethe goal, in addition to compensating the injured consumer, is to punish theinjurer. Today they are used for other purposes, sometimes in bizarre ways.20

If we keep in mind that consumers are paying through higher prices forgoods and services for whatever damage payments they ultimately receive, thensome principles are apparent. Damage payments are like insurance: consumerspay “premiums” as higher prices for products, and receive a payment if injured.Since consumers do find it worthwhile to purchase insurance against medicalcosts and lost wages, it is appropriate that injurers should also compensate forthis class of losses, although some coordination between payments from injurersand payments from direct insurers may be useful.21 Moreover, it would also bedesirable for payments for medical costs to be related to the level of medicalinsurance that consumers themselves choose so that the moral hazardassociated with unlimited medical reimbursement could be avoided, asdiscussed in Rubin, 1993. Even if there would be cases filed for compensationfor pecuniary damages, calculation of these damages is relativelystraightforward, and most such cases would be settled; there would be relativelylittle litigation over this class of damages.

If given a choice, consumers never buy insurance against pain andsuffering.22 There are sound theoretical explanations for this fact, involving theshape of utility functions and the fact that death or injury reduces the marginalutility of wealth.23 Moreover, consumers do not purchase such insurance whengiven a choice. This means that the value of such insurance is below its cost(including the costs of operating the system) and, since the cost of operating thetort system is higher than the cost of operating any other insurance system,consumers would be even less willing to pay for compensation for pain andsuffering through the tort system than in any other form of insurance. If, forexample, we believe that consumers would desire such insurance but that

Rubin: Tort-Contract Boundary Page 7problems of moral hazard and adverse selection prevent markets from offeringit, then we must realize that these problems also exist in using tort law toprovide the insurance, and are probably worse.24 Thus, it is likely that avoluntary contractual system would not provide compensation for nonpecuniarylosses. Since many cases are worth bringing only if there is a chance ofcollecting nonpecuniary damages, this reform would again reduce the number ofproduct liability cases filed. Moreover, since the level of nonpecuniary damagesis highly uncertain, litigation is more likely when this class of damages isrequested, so that the reduction in cases that go to litigation (which is moreexpensive) from elimination of nonpecuniary damages would be substantial.

Punitive damages are a more difficult issue. There are some behaviors offirms that normal tort damages will not adequately deter. These are behaviorsthat may approach criminality. Moreover, firms will sometimes make efforts tohide their behavior, and will sometimes be successful. Thus, normal penaltieswill sometimes be insufficient to provide optimal deterrence.25 Therefore, insome limited circumstances, punitive damages might be in the interest ofconsumers. A reasonable approach might be to require a higher standard ofproof of blameworthiness for punitive than for other damages. For example, thestandard might be the same as that in criminal law, proof “beyond a reasonabledoubt.” This would allow some punitive damages, but only in limitedcircumstances. This standard would eliminate many of the extreme casesobserved today. Again, since some matters are worth bringing only if there is achance of punitive damages, reducing their scope would reduce the number ofcases filed, and, since punitive damages are also uncertain, this would reducelitigation as well.

In sum, if contracts were allowed, consumers would probably wantstrict liability for manufacturing defects and negligence (perhaps with paymentsbased on comparative negligence) for design defects. Consumers wouldprobably want to be compensated for pecuniary damages, but not fornonpecuniary damages. In certain limited circumstances they might also wantpunitive damages. If warranties were allowed and disclaimers enforced, thenthese are the terms that would likely be agreed upon by buyers and sellers. Theterms would be in the warranty. The result would be many fewer filed cases.

Manufacturers would have the option of allowing different terms, andadvertising these terms. For example, a manufacturer stressing the safety of itsproduct might agree to pay nonpecuniary damages, and perhaps advertise, “Ourproduct is so safe that if a court ever rules that we have negligently caused adeath, we will provide a $1,000,000 additional insurance payment to survivors.”

On the other hand, George Priest has argued that actual consumerproduct warranties generally did not allow for payment for consequentialdamages, including injury, and that this is the form that warranties would likelytake in a regime of free contract.26 He suggests that the inefficiencies of tort laware so great that buyers and sellers will seldom find use of this body of lawdesirable for compensation. The tradeoff is between extra costs of insurance

Rubin: Tort-Contract Boundary Page 8(since first party insurance is much less expensive than third party insurancethrough the tort system) and extra safety through the incentives created by thetort system. If Priest is correct and warranties would disclaim consequentialdamages, this would imply that consumers would not be willing to pay the costsof the liability system for whatever additional safety use of this system wouldprovide. The issue is (or would be) empirical; as I indicated above, the actualmarket solution, if the market were allowed to function, would be the one weshould rely on. If Priest is correct, there would be even fewer filed cases.

II. Contract and Tort in a Coasian WorldNow consider a regime where the tort regime cannot be specified by

contract, but where juries are perfect agents for consumers. This model wouldbe consistent with fully informed rational jury self-interest. Since jurors are alsoconsumers and might be involved as plaintiffs in future cases, and since they willpay as consumers for any price increases caused by their decisions, rationalbehavior might lead them to be such perfect agents. Let us begin with a worldof Coasian perfect markets: No one makes errors and the legal system is able toadapt to whatever property rights and decision rules are in place.27

How would the courts behave if the liability were through tort ratherthan contract? In a perfect Coasian world, the location of liability should notmatter. A jury faced with an injured party would act as an agent for otherslikely to be in a similar situation in the future, and would apply liability rules andaward exactly that level and form of damages that the party would have wantedto contract for ex ante. Such a jury would not be concerned with the particularinjured party involved in the case because the cost of these injuries is sunk.Rather, the jury would reach a decision that would establish an efficientprecedent for future parties. Thus, in a products liability decision, a jury shouldaward exactly the amount that the injured party would have contracted toreceive in the event of injury ex ante if such contracts were enforceable. Jurieswould act as if instructions were: “The imposition of any damage payments willincrease prices paid by all consumers for goods and services in the future. Thus,you should consider the extent to which individuals might prefer to pay lowerprices for products instead of receiving compensation for actual losses or forpain and suffering.” Then the product price would reflect this level of damageawards, and would be the same as if liability had been assigned throughcontract.

With respect to liability standards, a jury might choose negligence-contributory negligence or a comparative negligence rule; either can beefficient.28 The definition of negligence would be that based on the Handformula, a cost-benefit measure.29 But the current regime, something called“strict liability” interpreted with some ambiguous negligence principles, wouldprobably never be chosen. If juries and courts behaved this way, then potentiallitigants would realize that they would have greatly reduced chances of

Rubin: Tort-Contract Boundary Page 9collecting, and would not file cases. Thus, the results would be equivalent tothose under a pure contractual regime.

Before discussing juries, however, I consider some of the literaturearguing that utility maximization is not the appropriate standard for the law, andsome literature claiming that consumers will often sign contracts that are not intheir interest because they suffer from information processing or cognitivedeficits that lead to systematic errors.

III. Should Consumers Negotiate Efficient Contract? Can They?30

The literature discussed here is part of a second generation criticism ofcontractual freedom. This criticism is part of a new set of defenses of thecurrent regime in which courts refuse to enforce many contracts. Initially, thoseopposed to freedom of contract made appeals to “unconscionability”,“unfairness”, the evils of “contracts of adhesion,” and “unequal bargainingpower.”31 Economic analysis of these arguments has shown their deep flaws32

so defenders have turned to new arguments.The economic analysis of product liability as a tort has developed two

major policy conclusions: Free contract should be allowed between buyers andsellers to establish the terms that will govern in the case of accident, andconsumers would prefer not to be compensated for nonpecuniary damages,including hedonic damages and pain and suffering, if they had a choice. Manylegal scholars, wedded to the current system, resist these conclusions.33 Suchscholars are turning to a new class of arguments.34 The conclusions of theeconomic analysis depend on the assumptions of rational, utility maximizingconsumers. In order to attack the results of the economic analysis, legalscholars are forced to attack one of these assumptions. Some believe that utilitymaximization is inappropriate. Others claim that consumers are not sufficientlyrational to engage in contract. I consider each stream of this literature; I discussthe anti-utility maximization arguments only briefly, and spend more time on theanti-rationality stream.

A. Should Law Aim at Utility Maximization?Some scholars have argued that the goal of utility maximization or

preference satisfaction is incorrect. Most prominent is the article by Croley andHanson.35 The simplest form of their argument is that accidents and otherreductions in wealth may in theory increase the marginal utility of wealthinstead of reducing it, so that it is theoretically possible that nonpecuniarydamages would be justified. This is unobjectionable, and, as they recognize, notnovel. But they also present a more complicated argument consistent with non-utility maximizing behavior. They argue that individuals might contemplatealternate utilities in different states of the world and decide to shift wealth (andthus utility) to states where the “baseline” utility is lower. This decision mightbe made even if it is inconsistent with rational maximizing behavior (that is,with shifting wealth to higher marginal utility states). They call individuals who

Rubin: Tort-Contract Boundary Page 10have such preferences “equimaxers” to distinguish them from “maximizers.”This argument, however, rests on explicit non-maximizing behavior, and thus isat best problematic.

In an unusual article, Pryor rejects the standard utility analysis of risk,and argue that risks should be valued from the perspective of the injured personrather than of the uninjured decision maker.36 Her claim is that uninjuredpersons cannot understand the utility function of those who are injured ordisabled, and so ex ante judgments of ex post marginal utility should not count.Such a theory is fundamentally inconsistent with expected utility maximization,or indeed, with rational decision making. Any experience might change ex postutility relative to ex ante anticipation, but we do not on this basis prescribeconsumer choices. Most specifically, her theory would seem to imply that allinsurance policies should have a mandatory “pain and suffering” component,since those purchasing insurance would undervalue this category.

Feldman believes that there should be compensation for nonpecuniarylosses, but she reaches this conclusion by rejecting economic analysis and byarguing that “preferences should not determine tort awards.”37 Rather, shewould allow some measure of paternalism in deciding on optimal tort policy.But again, an argument rejecting preferences is a peculiar argument, at leastfrom the perspective of maximization of welfare, the starting point of economicanalysis.

In a sense, it might be argued that these articles indicate the correctnessof the economic approach. If the only arguments against this approach arebased on achieving something other than maximization of consumer welfare,then the arguments must be convincing for those who value human satisfactionas a goal.

B. IrrationalityThe second stream of articles criticizing the economic approach argue

that people in entering into transactions are not sufficiently rational to do socorrectly. These arguments are based on alleged errors in human decisionmaking, found by both economists and psychologists in experimental laboratorysituations.

Before discussing particular examples of this analysis, a caveat isneeded. There is no doubt that in experimental situations, subjects commitpredictable errors, of the sort discussed below and elsewhere in the literature.But there is a real debate regarding to the extent to which these errors affectactual market behavior. For example, experimental markets seem to giveefficient outcomes, even though individual participants may behaveinefficiently.38 It may be that, even if individuals make errors, market forces aresufficiently powerful to override these errors, as Becker argued long ago,39 andthat major policy outcomes should not be based on a preliminary and contestedliterature. In addition, I do not believe that the policy claims are justified by theliterature. In what follows I critique arguments for restrictions on free

Rubin: Tort-Contract Boundary Page 11bargaining which have been made by Richard Hasen, Howard Latin, MelvinEisenberg.

Richard Hasen40 uses psychological analyses of decision making underuncertainty to attempt to shed light on contract and tort issues. His argument isthat since there are known biases in consumer processing of information, thelegal system should take these into account. In the context of this analysis, thisargument would indicate that reliance on contracts would be inefficient becausepeople would agree to inappropriate contracts. In particular, Hasen isconcerned with “framing” effects, the fact that in laboratory experimentssubjects treat decisions differently if the payoffs resulting from these decisionsare expressed (“framed”) in terms of losses or gains. For example, subjects areapparently more willing to try an experimental medicine if they are told that“80% of the people taking this medicine will survive” than if they are told “20%of the people taking this medicine will die.” (Experienced physicians are subjectto the same bias.) Hasen claims that in many contexts, manufacturers takeadvantage of this bias in providing contractual terms and that the legal systemshould adjust.

There are two problems with this analysis. First, it proves too much: theissues raised by Hasen apply to many aspects of seller behavior, not just tocontract terms. Second, the same biases would be exhibited by other legaldecision makers. In particular, as discussed below, courts would be subject tothe same biases, and therefore the legal system might not be able to correct theproblems Hasen identifies.

As an example of overgenerality, Hasen discusses the credit terms madefamous in Williams v. Walker-Thomas Furniture Co.,41 the well-knownWashington, D.C. case in which the terms of a credit contract were overturnedas being unconscionable. The term can be expressed in terms of gains or oflosses:

Term G (Gain frame): The buyer may retain all of the goods purchasedfrom the seller provided that all payments are made on time to the seller.If all payments are not made on time the buyer may not retain thegoods.Term L (Loss frame): The seller will not repossess all the goodspurchased by the buyer provided that all payments are made on time tothe seller. If all payments are not made on time the seller will repossessthe goods.42

Hasen claims that expressing the contract in the Gain frame will beperceived as more desirable by potential buyers and will lead to larger sales andprofits than expressions in the Loss frame. He therefore suggests that legaldefinitions of unconscionability be expanded to include framing effects, so thatcontracts framed in the “gain” mode would be unconscionable.

Rubin: Tort-Contract Boundary Page 12But the same effects exist, if they exist at all, with respect to all product

characteristics. Advertisers generally provide information in Gain frames.Automobile manufacturers advertise that “Our car will get 20 miles per gallon”not “Our car will get no more than 20 miles per gallon.” Macy’s advertises a“One day sale” not “364 days of higher prices.” Portable computers advertise“Four hour battery life” not “If you leave our computer on for more than fourhours, you will lose your data.” If advertisers provided this sort of adverseinformation, consumers would view them as demented. Moreover, the fact thatall advertisers provide claims in gain frames means that consumers are used tointerpreting commercial information in this way, and presumably able todiscount any framing effects. Like many legal scholars writing about contracts,Hasen treats contract terms as if they were different than other productcharacteristics. However, arguments that apply to contractual terms also applyto other aspects of products, and there is no reason to treat terms as different.

Next, Howard A. Latin43 has argued that people make systematic errorsin interpreting warnings, and that the use of warnings to eliminate liability istherefore bad policy.44 That is, he would eliminate any defense in a productliability action based on the existence of an adequate warning.

It is difficult to know exactly what to make of this article. It does nottake a deep knowledge of modern cognitive theory – or graduate training in lawor economics – to know that some consumers sometimes do not follow allwarnings meticulously. But what does this simple fact (expanded into 100 lawreview pages with 439 footnotes) tell us? Virtually nothing. The goal is thesolution to some maximization or minimization problem. For the answer to sucha problem, more than qualitative information is needed; we must have someway of determining the optimal level of care and warnings, and simplydemonstrating that there are complex ways in which warnings may fail does nothelp us make the necessary calculations.

Latin virtually admits as much. When he discusses policy, he agrees thatall actual tests will be suboptimal, and that the factors he discusses are difficultto factor into a legal decision. However, he prefers to err on the side of “toomuch” safety even though he understands that this will impose costs on society.In fact, it appears that his entire analysis of cognitive errors is simply aimed athis goal of arguing for stricter liability whenever possible. Indeed, although hedoes pay lip-service to cost benefit analysis, he discusses the amount of safetywhich is “feasible” as a goal throughout the paper, and argues that firms shouldmake products safer rather than relying on warnings.

There are other difficulties in Latin’s analysis; I discuss one. A key pointin the analysis is the distinction Latin draws between the “Rational RiskCalculator” (RRC) and the “Mistake and Momentary Inattention” (MMI)models. The first, of course, is the basic law and economics model, whichassumes that consumers rationally calculate risk-benefit tradeoffs and makeproduct purchases accordingly. The latter is his preferred model, and assumesthat accidents are due to the named factors. But the inconsistency between

Rubin: Tort-Contract Boundary Page 13these models is more imagined than real. One dimension on which products maybe safer is exactly their ability to counter momentary inattention. Antilockbrakes, to take a relatively familiar example, are particularly beneficial if a driversuddenly observes (as the result of a moment of carelessness or inattention,perhaps) that unless he jams the brakes immediately, he will have an accident. Ifthe brakes still do not do the job, seat belts, air bags, or merely driving a heaviercar, will still minimize the impacts of the carelessness. Warnings can allowconsumers to make appropriate decisions regarding the likely effects ofexpected levels of inattention, where one decision may be buying theappropriate product.

Finally, Melvin Eisenberg45 uses arguments from the theory of cognitiveerrors to explain the courts’ unwillingness to enforce contractual terms inseveral contexts. Here we consider his discussion of “standard form contracts.”Eisenberg takes the standard analysis of “contracts of adhesion” and dresses itup on modern psychological terminology. The devils in Eisenberg’s analysis are“bounded rationality, optimistic disposition, systematic underestimation of risks,and undue weight on the present as compared with the future.” But the chiefdevil, and the one discussed most, is “rational ignorance.” Sellers know thingsabout contracts that buyers do not know because it does not pay buyers toknow them, and sellers use this knowledge to “slant things in favor of the formgivers.”46

There are three major errors in Eisenberg’s analysis (and in the analysisof adhesion contracts in general). These are: treating contract terms as beingdifferent from other elements of the product; assuming that contract terms arethe main determinant of firm behavior; and ignoring price effects.

Perhaps because lawyers (including academic lawyers) study contractformation but not actual manufacturing of real goods, they seem to believe thatcontract terms are different than other product characteristics. Let me quotefrom Eisenberg at some length:

First, a form contract often contains a large number of legal terms. Forminsurance contracts, for example, typically contain thirty, forty, or moreterms. Moreover, the meaning and effect of the preprinted provisionswill often be inaccessible to lay persons. In part, this is because theterms are often written in exceedingly technical prose. Even if the termsare clearly written, however, the form taker will usually be unable tofully understand their effects, because preprinted terms characteristicallyvary the form taker’s baseline legal rights, and most consumers do notknow their baseline rights.47

Now consider a slightly (but not misleadingly) altered version of this paragraph:

First, a computer often contains a large number of parts.Laptops, for example, typically contain thirty, forty, or more

Rubin: Tort-Contract Boundary Page 14parts. Moreover, the purpose and use of the parts will often beinaccessible to lay persons. In part, this is because the partsoften perform exceedingly technical functions. Even if thefunctions are clearly explained, however, the computer buyerwill usually be unable to fully understand their effects, becauseparts characteristically vary the chip’s baseline performance, andmost consumers do not know their chip’s baseline performance.

Conclusion? Because of asymmetric information and the fact that many of theparts of my computer or software will not be used often (or at all, for any oneuser) we must still all be using 1960s IBM mainframes, and the machine onwhich I think I am writing this is an illusion.

Silly? Perhaps. Unfair? I don’t think so. The world is full of highlycomplex products made of numerous obscure parts, and of chemicals withunpronounceable names performing highly technical and unintelligible functions.We rationally don’t know much about any of these things – no more, andperhaps less, then we know about contract terms. But that does not mean thatthe manufacturers “slant” the products towards themselves. On the contrary,manufacturers, driven by forces of competition, are constantly changingproducts to improve them, even though we may not understand why or how. Itis difficult to understand how contract terms are different.

The other two points have already been addressed. Eisenbergoverweighs the importance of contract terms in determining firm behavior andperformance. Contract terms are only a part – a small part – of what motivatesfirms. Firms produce products and honor agreements because reputations arevaluable, and anything they do that lowers the value of reputations has severeconsequences for the firm.

Finally, price. As Atiyah has recently noted, “[E]conomists are nowtrying to remind lawyers (though here with, so far, little success) that interferingwith some of the terms of a contract probably only affects the price of thebargain, and so may be idle or positively harmful to those who it is sought tohelp.”48 Like Hasen, Eisenberg spends much of his analysis on Williams v.Walker-Thomas Furniture. What Eisenberg does not address is the effect of thisdecision on the costs of credit to consumers in Washington – the ”price of thebargain.”

The critique of “contracts of adhesion” has the analysis exactlybackwards. In private markets, there is a chance for competition, and if buyersdo not like the terms offered by one seller and are willing to pay the costs ofmore favorable terms, other sellers can be expected to compete and offer betterterms. But if the courts order all sellers to offer the same terms, then buyers areforced to buy on those terms or go without. There is no possibility foralternative contract terms, no matter how much the consumer may dislike thecourt imposed terms. Thus, the true contracts of adhesion with take-it-or-leave-it terms are those written by the courts; it is these contracts that are inescapable,

Rubin: Tort-Contract Boundary Page 15and these terms that can not be avoided. Moreover, these terms have beenwritten by self-interested parties, interested in their own incomes, just asEisenberg alleges happens in standard form contracts. The difference is that, inthe former case, the parties are attorneys rather than manufacturers, and thatthere is no possibility of competition or change as long as the courts refuse toenforce contractually-specified terms.

IV. Will Juries Get It Right?Since tort has replaced contract for product liability issues, one major

impact is that cases are tried as accidents, rather than being decided ascontractual issues. In addition, many more cases are brought and tried; in acontractual regime, many matters that now lead to liability would not generatelitigation. As argued above, if courts were perfect agents for parties to futuretransactions, then this change should not matter. I first present some evidenceshowing that juries do not even attempt to choose efficient rules, and in factresent attempts to inform them of such terms or to induce them to accept them.I then discuss the applicability of the literature on cognitive errors to juries, andshow that we would expect the results of this literature to exactly apply to courtdecisions – even more than to consumers engaging in transactions. Finally Ishow that this literature suggests that juries should be expected to make poordecisions.

A. PintoJuries seldom have a chance to consider explicit cost-benefit analysis,

for reasons that will be clear. There was one famous case where a jury wasconfronted with exactly such evidence, and the result was a public policydisaster. This was the Ford Pinto case.49 Schwartz50 persuasively shows thatjuries are totally unwilling to accept any hint of an analysis explicitly measuringthe cost of lives saved. This is true even when the law expressly requires suchbalancing. It was the fact that Ford had undertaken such calculations thatinduced the jury to award large punitive damages in this case. Moreover, thestrength of the jury’s ire was sufficiently strong so that virtually no defenselawyer is willing to make arguments relating to cost. Schwartz’ distillation ofconversations with several defense lawyers contains the following statement:51

However, one argument that you should almost never make is that themanufacturer deliberately included a dangerous feature in the product’sdesign because of the high monetary cost that the manufacturer wouldhave incurred in choosing another design. If you do argue this, you’realmost certain to lose on liability, and you can expose yourself topunitive damages as well.

But arguments regarding the cost of safety improvements are theessence of efficient, rational decision making with respect to safety.52 If such

Rubin: Tort-Contract Boundary Page 16arguments cannot be made before a jury, then it is unlikely that juries canefficiently act as agents for consumers, and unlikely that reliance on juries willlead to correct outcomes. Indeed, because of the results of Pinto and the abilityof plaintiffs to obtain documents through discovery, this case has probablymeant that many firms are unwilling to even undertake such cost benefit analysisfor internal planning purposes, let alone to make such arguments before a jury.In this sense, Pinto has probably lead to excess harm and injury in the economy.

B. Is Experimental Evidence Relevant for Juries?I mentioned above that there is a major debate in the economics

literature regarding the extent to which experimental evidence on cognitiveerrors is relevant for analyzing market behavior. But this debate is not relevantin the case of juries. Rather, individuals serving on juries are in virtuallyidentical situations as experimental subjects. Moreover, jurors are in a situationwhich would almost maximize the chance of reaching erroneous or irrationaldecisions.

Experimental evidence of errors in decision making was first providedby psychologists. Economists were skeptical of these results, and attempted toreplicate the experiments in order to correct for what they perceived asmisspecifications. Camerer indicates53 that the main differences are thatpsychologists use natural stimuli, do not pay subjects, and do not repeat tasks.Economists pay subjects, prefer blandly labeled random devices as stimuli, andinsist on repeating tasks.

Consider a jury. It makes a decision about an accident that has already(really) occurred, the essence of a natural stimulus, and moreover often onewith a substantial emotional load. Jurors are not paid for correct decisions.Finally, cases and juries are unique, so there is no chance of a juror repeatingthe situation and learning of correct answers.

The efforts of experimental economists were aimed at finding treatmentsthat would lead subjects to make more rational decisions. The changes intreatment used by economists went some distance (though not all the way)towards achieving this goal. Thus, to the extent that the institutions governingjuries are like those used by psychologists and unlike those used by economistsin experiments, then these institutions are more likely to lead to relatively lessrational decisions and to more cognitive errors.

Many of the scholars discussed above (Hasen, Latin, Eisenberg) arguedthat cognitive effects would lead to biases in decision-making so that consumerswould likely make errors in signing contracts. They used this argument tojustify interference with contractual freedom, and court intervention in privatetransactions. But interference with free contract will imply that morecontractual disputes will go to juries. Juries are more likely to be subject to biasthan are consumers. Consumers sign many contracts and buy many products.Consumers pay directly whatever costs are associated with errors, and soreceive feedback from erroneous decisions. Thus, consumers have a chance to

Rubin: Tort-Contract Boundary Page 17learn. Juries have no such chance. Jurors (as consumers) may end up payinghigher price for goods and services because of their decisions as jurors, but thelink is neither obvious nor immediate. As a teacher of law and economics, I cansay that it is not intuitively obvious either. Thus, if we believe that cognitivebiases are important in decision-making (and I am personally ambivalent on thisissue), then we must believe that they are more severe with respect to jurorsthan with respect to individuals engaging in exchange for their own benefit.

C. Expected Jury BiasesWhat does the cognitive literature tell us about particular biases we

might expect from jurors in product liability matters?54 In general, thepredictions all point in the same direction: juries are likely to award damagesmore often and award higher damage payments than consumers would desire exante. This additional level of payments will arise partially through a greaterlikelihood of finding liability and partially through awarding larger damages thanwould be desired ex ante. Since the errors discussed are systematic, there is nopresumption that awards would be random, and a finding of predictability inpain and suffering awards would not be inconsistent with the theory proposedhere.55 Awards will be predictable and they may be internally consistent, butthey will be biased upward relative to efficient levels.

Consider first liability. In a negligence system (and in the odd version of“strict liability” that governs our current product liability system) a firm isnegligent if it does not take all cost justified precautions. But of course whethera precaution is cost justified depends in part on the probability of the harmfulevent occurring. A jury observes the product after an accident has happenedand must then attempt to infer what level of precautions would have beenefficient when the product was made and sold. There are reasons to expect thatjuries will form incorrect estimates of the relevant probability.

One common cognitive error is “hindsight bias.”56 Once an event hasoccurred, then subjects view the probability of that event as being greater thanbefore the event occurred. Thus, a jury, faced with an already existing accident,will believe that the probability of the accident ex ante was greater than may beobjectively true. Therefore, even if a firm behaved non-negligently and took allcost justified precautions, a jury may find negligence because of its overestimateof the probability of the accident. There is both actual57 and experimental58

evidence of the importance of hindsight bias in a litigation context, leading toexcessive liability.

A similar result follows from what has sometimes been called the “lawof small numbers.”59 This is the tendency of experimental subjects toovergeneralize from small samples. Thus, if the major relationship jurors havewith some product is observation of the effects of a mishap regarding thisproduct, then the jurors might well view the product as being more dangerousthan it is, again giving rise to overestimates of the risk associated with theproduct.

Rubin: Tort-Contract Boundary Page 18Two other effects identified in the cognitive literature will reinforce this

overestimate of probabilities of harm. First, there is evidence that lowprobability events (approximately, events with probabilities less than .2) areoverweighed in decision making,60 and product injuries are very low probabilityevents. Second, subjects tend to be overconfident of the accuracy of theirassessments of probabilities61 so that there is no obvious mechanism that wouldlead to correction of these erroneous estimates. Jurors would be expected to beoverly confident of their estimates of proper damage levels, so there is noreason to expect juror doubt or uncertainty to reduce the level of damages.Subjects also have a biased tendency to interpret new evidence as consistentwith their initial hypothesis, so that if jurors start with a belief that the defendantfirm is probably negligent, then they will confirm this belief too often.62

Finally, there is evidence that individuals greatly undervalue“probabilistic insurance,” defined as “an action that reduces but does noteliminate the probability of a loss.”63 Many products involved in productsliability are exactly of this sort. Medical care and pharmaceuticals reduce but donot eliminate risks, and much litigation is in fact over the remaining risk.64 Tothe extent that jurors undervalue the risk reduction that has occurred, so theywill undervalue the benefits of the product, and be excessively likely to findliability. The cost of excess liability for such risk-reducing products isparticularly high, since such liability can lead to increased prices reducedamount demanded for risk-reducing products, such as vaccines.65

As for damages, it is very likely that juries will find greater levels ofdamage payments when viewing an accident ex post than consumers wouldhave wanted to contract for ex ante. One of the major results of cognitiveexperiments is that losses are overweighed relative to gains. Before an accident,both the accident and the payment for the accident may be viewed as losses (“Ifyou are injured, you will lose $10,000 in wages and medical payments.” “If youare covered for these injuries, you will pay $10 more for this product.”) Thus, itmay be that consumers will weight gains and losses approximately correctly.Moreover, consumers ex ante are accustomed to making exactly thesecalculations routinely in markets. But after the accident the actual suffered losswill have excess weight.

One important element discovered by cognitive scientists is the“endowment effect.” “Individuals evaluate choices based on absolute changes invalue, from a baseline that is typically the status quo, attaching more disutilityto losses than utility to gains, and being highly subject to purely formal orsemantic manipulation, as in the specification of the status quo, throughout.”66

One implication is that losses are overvalued relative to gains. But once theaccident has occurred, then all that is salient are losses. Losses, not productbenefits or money saving from reduced prices, are the entire focus of the trial.Indeed, the evidence from Pinto, cited above, suggests that jurors are unwillingto consider the ex ante perspective (that is, the perspective of the cost ofadditional precautions.) Therefore, cognitive theory indicates that juries will

Rubin: Tort-Contract Boundary Page 19systematically place more weight on the actual accident and award more indamages than consumers would desire ex ante.

There is even some experimental evidence demonstrating this. Calfeeand Winston have shown that ex ante consumers are not willing to pay muchfor compensation for pain and suffering, as the theory would predict.67 On theother hand, experimental studies of ex post compensation for pain and sufferingreport, consistent with cognitive theory, that the “frame” in which the problemis set determines the outcome. McCaffery et al. test an additional implication ofthe endowment effect, the difference between “willingness to pay” and“willingness to accept.”68 There is strong experimental evidence that consumerswill demand more to give something that they own up than they would bewilling to pay to buy the same item. In an injury context, this implies that ifjurors are asked to award compensation based on the ex ante (selling price)perspective, values should be larger than if the award is framed in terms of theex post (making whole) perspective; and this is what they find. Of course, bothamounts provide more insurance and compensation than the true ex anteamount that theory would predict consumers would be willing to pay for, andmore than is consistent with the experimental evidence provided by Calfee andWinston.

This argument is especially relevant for Hasen’s analysis, discussedabove. Assume that Hasen is correct and there are framing effects, so that areturn expressed as a loss is viewed as less desirable than the value of the samereturn expressed as a gain. Now consider a jury. In a products liability case, thejury is faced with an actual rather than a potential loss. Thus, the jury beginswith a loss frame. If framing effects lead to a bias, then juries should beespecially susceptible to this bias. If we accept Hasen’s arguments regardingframing effects, then we should rely more on contract and less on tort thanotherwise because many product related juries will not lead to litigation under acontract analysis.

Two other factors identified in the cognitive literature cut in the samedirection, towards increased damage payments. First, after an accident, thevictim is identifiable; indeed, he (or his heirs) is in court. Before the accident,the chance of harm is to a “statistical” or unidentified individual. But there isevidence that people tend to overweight harms to identifiable individualsrelative to harms to statistical individuals.69 Second, there is evidence of“anchoring” in decision-making – a failure to fully adjust initial estimates ofvalues using Bayes theorem to reflect new information.70 But the jury beginswith a loss and a claim for damages, rather than with a neutral expected valuecalculation. If awards are adjusted from the initial point, then they will again bebiased upwards.

Note that most of the experimental literature discussed above deals withindividuals (or with individuals bargaining or trading with each other.) A jury isa collective decision-maker, and so might behave somewhat differently.However, if all individuals are subject to some bias, then a collective composed

Rubin: Tort-Contract Boundary Page 20of those same individuals should be subject to the same bias. Indeed, in theexperimental simulations of juries mentioned above, 71 decisions were made byindividuals told to behave as jurors; no experimental aggregation wasperformed.

V. Would Judges Do Better than Juries?It might appear that one factor determining the outcome of litigation is

whether the case is decided by a judge or by a jury. If some question is decidedas a matter of law, it is decided by a judge; if it is treated as a matter of fact, itgoes to a jury. A common theme from the nineteenth century to today is theeffort to keep issues out of the hands of juries. Atiyah, for example, states that“Juries were not only unpredictable; they were slow.”72 Gilmore discusses the“uneasy, inarticulate distrust of the role of the civil jury.”73 It is generallythought that the purpose is to prevent the natural sympathetic or redistributiveimpulses of jurors from leading to inefficient or otherwise undesirableoutcomes. Others believe that this effort was and continues to be a class-basedeffort aimed at preserving the status quo in society.74 The argument here is thatjuries will make systematic errors that will harm consumers.

However, it is quite possible that judges are almost as subject to the sortof cognitive errors discussed above as are jurors. Judges do see many cases,and so it would appear that they would have a chance to learn. Nonetheless, tothe extent that decisions have effects in markets, judges do not actually observethe results of their decisions, since judges do not study markets, and wouldtherefore not receive the feedback needed to be able to improve their decisionmaking. As Cammerer discusses at several points, when “experts” are given thesame tasks as students in experiments, then they do about the same as studentsin settings where there is little feedback, although they do better where there ismore feedback (e.g. in weather forecasting).75

The distinction between tort and contract is apparently in part an issueof framing, as discussed above. If an injury is treated as a tort, then decision-makers, judges or jurors, seek to assign appropriate damages. If such injurieswere treated under contract and if there were clear disclaimers, then decision-makers would perforce be bound to find different results. Moreover, moreimportantly, as I have argued above, many fewer cases would be brought in thefirst place if such matters were treated as contractual issues. Thus, the legalframework governing product related injuries apparently has great significance.

ConclusionEconomic analysis indicates that treating injuries associated with

purchased products would be more efficiently handled under contract, wherethere is scope for competition to craft efficient rules and remedies. This ofcourse is contrary to the current practice, where such injuries are treated astorts. Recently, some supporters of this tort-based product liabilityjurisprudence have argued for this preference because they have claimed that

Rubin: Tort-Contract Boundary Page 21utility maximization is incorrect as a goal for law; this is a puzzling argument.Others claim that modern findings about peoples’ cognitive abilities suggest thatindividuals cannot rationally enter into contracts. But if tort replaces contract,then courts will make decisions for individuals, and there is no reason to expectcourts to be exempt from the cognitive errors attributed to consumers. Indeed,there are reasons to expect juries and perhaps judges to do even worse.

Defenders of the current tort system sometimes argue in terms ofempowerment of consumers. They argue that consumers should retain theirright to trials in product liability matters. Moving from tort to contract does notreduce consumers’ rights. Rather, it given them an additional right, the powerto sign contracts and agree not to pay to have their cases heard by a court.Since there are reasons for expecting courts to make systematic mistakes thatcost consumers money and reduce social wealth, the right to waive trialsthrough binding contracts is valuable and should be returned to consumers.

*. Helpful comments were received from participants at the Donner Conference and ata seminar at Emory University. Blame for errors remains with the author.

1. For notational convenience, I will refer to these as “product liability” in whatfollows. This is the only type of tort law that I address.

2. P.S. Atiyah , The Rise and Fall of Freedom of Contract, Clarendon Press, Oxford(1969); Grant Gilmore, The Death of Contract, Ohio State University Press, Columbus(1974).

3. For some examples: John E. Calfee and Paul H. Rubin, Some Implications ofDamage Payments for Nonpecuniary Losses, 21 J. Legal Stud. 371 (1992); Richard A.Epstein, The Legal and Insurance Dynamics of Mass Tort Litigation, 13 J. Legal Stud. 475(1984); Peter W. Huber, Liability: The Legal Revolution and Its Consequences, Basic Books(1988); Michael I. Krauss, Tort Law and Private Ordering, 35 St. Louis University L.J. 623(1991); George L. Priest, The Current Insurance Crisis and Modern Tort Law, 96 Yale L.J.1521 (1987); Paul H. Rubin, Tort Reform By Contract, AEI, Washington, D.C. (1993); AlanSchwartz, Proposals for Products Liability Reform: A Theoretical Synthesis, 97 Yale L. Rev.353 (1988). For an interesting variant, see Robert Cooter, “Commodifying Liability,” thisvolume.

4. The literature on cognitive decision making is immense, and I will neithersummarize it nor provide comprehensive references. Many of the articles I cite below providesummaries. I rely most heavily on Colin Cammerer, “Individual Decision Making,” Chapter8 in John H. Kagel and Alvin E. Roth, The Handbook of Experimental Economics, PrincetonUniversity Press (1995), and, to a lesser extent, on Roger G. Noll and James E. Krier, SomeImplications of Cognitive Psychology for Risk Regulation, 19 J. Legal Stud. 747 (1990). For adiscussion of the legal literature involving this research, see Donald C. Langevoort,Behavioral Theories of Judgment and Decision-Making in Legal Scholarship: A LiteratureReview, Vanderbilt L. Rev. Symposium on Human Behavior, Behavioral Economics, andLaw (1998; in press).

5. This section is based in part on Paul H. Rubin, Fundamental Reform of Tort Law,

Rubin: Tort-Contract Boundary Page 22 Regulation, 1995, Number 4, 26-33.

6. William Landes and Richard Posner, The Economic Structure of Tort Law,Cambridge, Mass, Harvard University Press (1987).

7. Steven Shavell, The Economics of Accident Law. Cambridge, Mass.: HarvardUniversity Press (1987).

8. For a general discussion of reputation, see Daniel B. Klein, editor, Reputation:Studies in the Voluntary Elicitation of Good Conduct, the University of Michigan Press,1997, and particularly Klein, Trust for Hire: Voluntary Remedies for Quality and Safety, pp.97-133.

9. Indeed, as discussed below, the nature of cognitive decision making is such that theloss in reputation may be greater than would be warranted by the injury, since individualsseem to overweigh losses.

10. Mark L. Mitchell, The Impact of External Parties on Brand-Name Capital: The 1982Tylenol Poisonings and Subsequent Cases, 27 Economic Inquiry, October, 601 (1989); MarkL. Mitchell and Michael T. Maloney, Crisis in the Cockpit? The Role of Market Forces inPromoting Air Travel Safety, 32 J.L. & Econ., October 329 (1989); Sam Peltzman and GreggJarrell, The Impact of Product Recalls on the Wealth of Sellers, 93 Journal of PoliticalEconomy 512 (1985); George E. Hoffer, Stephen W. Pruitt, and Robert J. Reilly, The Impactof Product Recalls on the Wealth of Sellers: A Reexamination, 96 Journal of PoliticalEconomy 663 (1988); Paul H. Rubin, R. Dennis Murphy, and Gregg Jarrell, Risky Products,Risky Stocks, Regulation, No. 1, 35 (1988); W. Kip Viscusi and Joni Hersch, The MarketResponse to Product Safety Litigation, 2 Journal of Regulatory Economics, 215 (1990).

11. Economic Report of the President, Washington, 1997, Table B-29.

12. Aaron Wildavsky, Searching for Safety, Transaction Books, 1987.

13. J. Mark Ramseyer, Products Liability Through Private Ordering: Notes on aJapanese Experiment, 144 University of Pennsylvania L. Rev. 1 (1996).

14. The original analysis is in John P. Brown, Toward an Economic Theory of Liability,2 J. Legal Stud. 323 (1973).

15. Christopher Curran, The Spread of Comparative Negligence in the United States, 12Int. Rev. L. & Econ. 317 (1992).

16. George L. Priest, Strict Products Liability: The Original Intent, 10 Cardozo L. Rev.2301 (1989).

17. W. Kip Viscusi, The Dimensions of the Product Liability Crisis, 20 J. Legal Stud.147 (1991).

18. James A. Henderson and Aaron D. Twerski, Doctrinal Collapse in ProductsLiability: The Empty Shell of Failure to Warn, 65 New York University L. Rev. 265 (1990).

19. To be fair to the lawyers, I should point out that this class of damages was invented

Rubin: Tort-Contract Boundary Page 23 by an economist. For a history see John O. Ward, editor, A Hedonic Primer for Economistsand Attorneys, Lawyers and Judges Publishing Co. (1992).

20. For a discussion of one such case, with some analysis of the economics of punitivedamages, see Paul H. Rubin, John E. Calfee and Mark F. Grady, BMW v Gore: MitigatingThe Punitive Economics of Punitive Damages, 5 Supreme Court Econ. Rev. 179 (1997).

21. These payments are called “subrogation.” Subrogation -- payment from the injurerto the victim’s insurance carrier -- seems to be common in automobile accidents, but not inother accidents. It may be that the transactions costs of determining if such payments areavailable are too great, given the relatively small number of tortious injuries. Further researchon this topic would be useful.

22. Steven P. Croley and Jon D. Hanson, The Nonpecuniary Cost of Accidents: Pain-and-Suffering Damages in Tort Law, 108 Harvard L. Rev. 1785 (1995) claim that consumersdo want such insurance, and purport to provide examples, but come up with only a fewmarginal instances where insurance decisions are difficult to explain. The article is criticizedin more detail below and in John E. Calfee and Paul H. Rubin, Indicting Liability: How theLiability System Has Turned Against Itself, American Enterprise Institute, Washington(forthcoming 1998).

23. The strongest theoretical argument for such payments is Mark Geistfeld, Placing aPrice on Pain and Suffering: A Method for Helping Juries Determine Tort Damages forNonmonetary Injuries, 83 California L. Rev. 773. However, this article does not provide auseful way of actually computing the optimal value for such damages, if they are desired, anddoes not consider risk reducing products such as medical care and vaccines. See Calfee andRubin, Indicting Liability, for a more complete discussion.

24. George Priest, The Current Insurance Crisis and Modern Tort Law, 96 Yale L.J.1521 (1987).

25. David D. Haddock, Fred S. McChesney, and Manachem Spiegel, An OrdinaryEconomic Rationale for Extraordinary Legal Sanctions, 78 California L. Rev. 1 (1990).

26. George Priest, A Theory of the Consumer Product Warranty, 90 Yale L.J. 1297(1981). Priest’s sample of warranties was obtained at a time when courts were alreadyunwilling to enforce such disclaimers, so it is not clear what form warranties would take nowif it were worthwhile for firms to spend resources crafting them.

27. These assumptions go beyond those needed for the Coase theorem, but I believe theyare in the spirit of such a world. Ronald H. Coase, The Problem of Social Cost, 3 J. L. &Econ. 1 (1960).

28. Christopher Curran and David D. Haddock, An Economic Theory of ComparativeNegligence, 14 J. Legal Stud. 49 (1985).

29. Richard A. Posner, Economic Analysis of Law 164 (1992).

30. The two major treatises on the economics of torts (Landes and Posner 1987, andShavell, 1987) both argue that contract is not an efficient solution to risks associated withpurchased products. The basic argument against contractual solutions for product liability

Rubin: Tort-Contract Boundary Page 24 problems is that product related injuries are rare events and consumers do not have enoughinformation to rationally contract regarding such risks. I have discussed this argument atlength in Rubin (1993) and will not repeat that discussion here.

31. George Priest, The Invention of Enterprise Liability: A Critical History of theIntellectual Foundations of Modern Tort Law, 14 J. Legal Stud. 461 (1985).

32. For some examples, see Alan Schwartz and Louis L. Wilde, Intervening in Marketson the Basis of Imperfect Information: A Legal and Economic Analysis, 127 University ofPennsylvania L. Rev. 1979, and Imperfect Information in Markets for Contract Terms: TheExamples of Warranties and Security Interests, 69 Virginia L. Rev. 1387; Richard A. Epstein,Unconscionability: A Critical Reappraisal, 18 J.L. & Econ. 293 (1971); Sanford Grossman,The Informational Role of Warranties and Private Disclosure About Product Quality, 24 J.L.& Econ., 461 (1981); George Priest, The Current Insurance Crisis and Modern Tort Law, 96Yale L.J. 1521 (1987).

33. It is noteworthy that this belief is in the economic self interest of those holding it.See Paul H. Rubin and Martin Bailey, The Role of Lawyers in Changing the Law, J. LegalStud. 807 (1994); Richard A. Epstein, The Political Economy of Product Liability Reform, 78American Economic Review 311 (1988).

34. This is not to say that all scholars have abandoned the previous generation ofarguments; for example, see W. David Slawson, Binding Promises: The Late 20th-CenturyReformation of Contract Law, Princeton University Press, Princeton (1996), or JeanBraucher, The Afterlife of Contract, 90 Northwestern University L. Rev. 49 (Fall, 1995, aSymposium issue on “Reconsidering Grant Gilmore’s ‘The Death of Contract’”).

35. Steven P. Croley and Jon D. Hanson, The Nonpecuniary Cost of Accidents: Pain-and-Suffering Damages in Tort Law, 108 Harvard L. Rev. 1785 (1995).

36. Ellen Smith Pryor, The Tort Law Debate, Efficiency, and Kingdom of the Ill: ACritique of the Insurance Theory of Compensation, 79 Virginia L. Rev. 91 (1993).

37. Heidi Feldman, Harm and Money: Against the Insurance Theory of TortCompensation, 75 Texas L. Rev. 1567, 1577, 1582 (1997).

38. Cammerer, supra note 4, at 674-75.

39. Gary Becker, Irrational Behavior and Economic Theory, 70 J. Pol. Econ. (1962).

40. Richard L. Hasen, Comment: Efficiency Under Informational Asymmetry: TheEffect of Framing on Legal Rules, 38 UCLA L. Rev. 391 (1990).

41. 350 F.2d 445 (D.C. Cir. 1965).

42. Id. at 431.

43. Howard A. Latin, “Good” Warnings, Bad Products, and Cognitive Limitations, 41UCLA L. Rev. 1193 (1994).

44. W. Kip Viscusi, Individual Rationality, Hazard Warnings, and the Foundations ofTort Law , 48 Rutgers L. Rev. 625 (1996) points out that Latin was overly pessimistic

Rubin: Tort-Contract Boundary Page 25 regarding the extent to which individuals are unable to respond to warnings, and that they dohave a role in the tort system.

45. Melvin Aron Eisenberg, The Limits of Cognition and the Limits of Contract, 47Stanford L. Rev. 211 (1995).

46. Id. at 243.

47. Id. at 241.

48. P.S. Atiyah, An Introduction to the Law of Contract 30 (5th ed., Oxford: ClarendonPress, 1995).

49. Grimshaw v. Ford Motor Co., 119 Cal. App. 3d 757, 174 Cal. Rptr. 348 (1981).

50. Gary T. Schwartz, The Myth of the Ford Pinto Case, 43 Rutgers L. Rev. 1013(1991).

51. Id. at 1038.

52. I myself have numerous times attempted to convince product liability defenselawyers that economic testimony about cost-benefit analysis of the sort that is routinelyperformed at the Consumer Product Safety Commission would help their cases; they have allimplicitly agreed with the quoted statement.

53. Camerer, supra note 4, at 680.

54. For a similar analysis, but in a different context, see Cass R. Sunstein, BehavioralAnalysis of Law, University of Chicago, John M. Olin Program in Law and EconomicsWorking Paper No. 46, forthcoming, U. Chi. L. Rev.

55. As found by W. Kip Viscusi, Pain and Suffering in Product Liability Cases:Systematic Compensation or Capricious Awards?, 8 Int. Rev. L. & Econ. 203 (1988).

56. Cammerer, supra note 4, at 613.

57. Hal R. Arkes and Cindy A. Schipani, Medical Malpractice v. the Business JudgmentRule: Differences in Hindsight Bias, 73 Oregon Law Review 587 (1994) find that there issignificant hindsight bias in actual medical malpractice litigation.

58. Kim A. Kamin and Jeffrey J. Rachlinski, Ex Post � Ex Ante: Determining Liabilityin Hindsight, 19 Law and Human Behavior 89 (1995) find experimental subjects are likely tofind liability after an event has occurred in a situation where subjects viewing the samesituation before the event find precautions not worthwhile. In their experimental treatment,24% of the ex ante subjects found taking a precaution worthwhile, but 56% in the ex postsituation found negligence for failure to take the same precaution.

59. Cammerer, supra note 4, at 602.

60. See, e.g., id. at 641.

Rubin: Tort-Contract Boundary Page 26 61. Id. at 590-91.

62. Matthew Rabin and Joel Schrag, First Impressions Matter: A Model of ConfirmationBias, Emory University working paper, 1997.

63. Noll & Krier, supra note 4, at 758-59.

64. Calfee and Rubin, supra note 3.

65. Richard L. Manning, Changing Rules in Tort Law and the Market for ChildhoodVaccines, 37 J.L. & Econ. 247 (1994).

66. Edward J. McCaffery, Daniel J. Kahneman, and Matthew L. Spitzer, Framing theJury: Cognitive Perspectives on Pain and Suffering Awards, 81 Virginia L. Rev. 1341, 1353(1995). For discussion of some legal implications of the endowment effect, see HerbertHovenkamp, Legal Policy and the Endowment Effect, 20 J. Legal Stud. 225 (1991) and PaulH. Rubin and Christopher Curran, The Endowment Effect and Income Transfers, Research inLaw and Economics 225 (1995).

67. John E. Calfee and Clifford Winston,The Consumer Welfare Effects of Liability forPain and Suffering: An Explanatory Analysis, Brookings Papers on Economic Activity:Microeconomics, 133 (1993).

68. Supra note 66.

69. Noll and Krier, supra note 4, at 749.

70. Id. at 754.

71. Sunstein, supra note 54, McCaffery et al, supra note 66.

72. Supra note 1, at 390-91. See also at 123, 732.

73. Supra note 1, at 99. See also at 42.

74. Howard A. Latin, ‘Good’ Warnings, Bad Products, and Cognitive Limitations, 41UCLA L. Rev. 1193 (1994).

75. Cammerer, supra note 4, at 593-4, 611-612.