Econ 522 Economics of Law

Econ 522Economics of Law

Dan QuintFall 2013Lecture 17

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HW3 due Thursday

Midterm 1 is graded, will return bluebooks at end of lecture

Reminders

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Recapping ourstory to date…

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Efficiency Maximizing total surplus realized by everyone in society Scarce resources are owned by whoever values them most Actions are taken if social benefit exceeds social cost

Design a legal system that leads to efficient outcomes Once we set up the rules, we don’t expect people to act based on

what’s efficient We expect people to do whatever’s in their own best interest So the goal is set up the rules such that people acting in their

own best interest will naturally lead to efficiency

Our story so far

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Coase gives us one way to do that If property rights are clearly defined and tradable, and there are

no transaction costs, people have incentive to trade until each resource is efficiently owned

So initial allocation of rights doesn’t matter for efficiency But if there are transaction costs, we may not get efficiency this way

Led us to two normative views of the legal system: 1. Minimize transaction costs (“lubricate” private exchange) 2. Allocate rights as efficiently as possible

Tradeoff between injunctive relief and damages

Our story so far

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Property law works well for simultaneous trade

Contracts allow for non-simultaneous trade

Contract law can… Enable cooperation Encourage efficient disclosure of information Secure optimal commitment to performance Secure efficient reliance Supply efficient default rules and regulations Foster enduring relationships

Our story so far

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So far, we’ve been talking about voluntary exchange Coase is predicated on exchange being voluntary for both parties Contracts are an extension of voluntary trade

Up next: “involuntary trade” You’re bicycling to class, I’m texting while driving and I hit you You didn’t want to deal with me, I didn’t want to deal with you…

Our story so far

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To put it another way…

Property law covers situations where transaction costs are low enough to get agreement ahead of time Exceptions to property law – private necessity, eminent domain –

when this isn’t the case

Contract law covers situations when transaction costs are low enough for us to agree to a contract, high enough that we may not want to renegotiate the contract later

Tort law covers situations where transaction costs are too high to agree to anything in advance

Our story so far

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Tort law

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An example

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An example

Choice Bad Luck Outcome+

punish the choice• criminal law

• regulations

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An example

Choice Bad Luck Outcome+

punish the choice• criminal law

• regulations

punish the combination of choice and outcome• “negligence”

punish the outcome• “strict liability”

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Tort, noun. from French word meaning injury

Contract law: situations where someone harms you by breaking a promise they had made

Tort law: situations where someone harms you without having made any promises

“If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.”

Tort law

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I hit you with my car, do $1,000 worth of damage You’re $1,000 worse off (No damage to me or my car) Should I have to pay you damages?

As always, we’ll be focused on achieving efficiency

–1,000–1,000–1,000Combined payoffs

–50,000–1,0000My payoff

49,0000–1,000Your payoff

I owe $50,000I owe $1,000I owe nothing

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Something to remember

distributionbut not

efficiency

efficiency

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Question: how to structure the law to get people to behave in a way that leads to efficient outcomes? Deliberate harms: make punishment severe (criminal law)

Accidental harms: trickier Goal isn’t “no accidents”; goal is “efficient number of accidents”

Tort law

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Question: how to structure the law to get people to behave in a way that leads to efficient outcomes? Deliberate harms: make punishment severe (criminal law)

Accidental harms: trickier Goal isn’t “no accidents”; goal is “efficient number of accidents”

Unlike nuisance law, injunctive relief is not an option

Unlike contract law, no agreement ahead of time

Cooter and Ulen: essence of tort law is “the attempt to make injurers internalize the externalities they cause, in situations where transaction costs are too high to do this through property or contract rights”

Tort law

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Plaintiff – person who brings a lawsuit

Defendant – person who is being sued

In a nuisance case, the defendant caused a nuisance, plaintiff was bothered by it, might be asking for injunction or damages

In a contract case, defendant breached a contract or violated its terms

In a tort case, defendant caused some harm to plaintiff, plaintiff is asking for damages

Plaintiff is the victim (person who was harmed)

Defendant is the injurer (person who caused the harm)

Cast of characters

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Harm

Causation

Breach of Duty

“Classic” legal theory of torts

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For a tort to exist, the plaintiff needs to have been harmed

“Without harm, there is no tort” Gas company sold gas with a defective additive

Dangerous for cars with turbocharged carburetors You have a car with normal carburetors You might be angry; but you weren’t harmed, so you can’t sue

Similarly, no compensation for exposure to risk Manufacturer exposed workers to some chemical Exposure will cause 15% of them to develop cancer later in life Can’t sue now – have to wait, see who gets cancer, then they can sue

Element 1: Harm

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Element 1: Harm

Money

Health

Perfect compensation restores victim to original level of well-being generally done through money damages

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Perfect Compensation

• Emotional harm• Pain and suffering• Loss of companionship

• Medical costs• Lost income• Damaged property

Intangible harmsTangible harms

In theory, perfect compensation should cover all losses Historically, courts have been less willing to compensate for intangible or

hard-to-measure losses Over time, U.S. courts have started compensating for more intangible harms Pro: the closer liability is to actual harm done, the better the incentive to avoid

these harms Con: disparity in award sizes, unpredictability

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Harm

Causation

Breach of Duty


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For a tort to exist, the defendant needs to have caused the harm to the plaintiff

Cause-in-fact “But for the defendant’s actions, would the harm have occurred?”

Element 2: Causation

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For a tort to exist, the defendant needs to have caused the harm to the plaintiff

Cause-in-fact “But for the defendant’s actions, would the harm have occurred?”

Proximate cause Immediate cause – defendant’s action can’t be too distant from the

harm Palsgraf v Long Island Railway (NY Ct Appeals, 1928):

Guard pushed a passenger to help him onto train, passenger dropped fireworks he was carrying, they went off, explosion knocked down scales at the other end of the platform, which fell on Mrs. Palsgraf

Guard’s actions were not the proximate cause


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“A tree fell on a moving trolly, injuring passengers. One of them sued.

He succeeded in demonstrating that in order for the trolly 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 trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.”

Court ruled driver’s negligence “had not caused the accident in the legally relevant sense”


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Harm

Causation

Breach of Duty


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Element 3: Breach of Duty

• Harm• Causation• Breach of duty (fault)

• Harm• Causation

NegligenceStrict Liability

When someone breaches a duty he owes to the defendant, and this leads to the harm, the injurer is at fault, or negligent Injurers owe victims the duty of due care Negligence rule: I’m only liable if I failed to take the required

standard of care – not if I was careful and the accident happened anyway

(Sometimes required, sometimes not)

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“A tree fell on a moving trolly, injuring passengers. One of them sued.

He succeeded in demonstrating that in order for the trolly 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 trolly would not have been under the tree when it fell, so, the plaintiff argued,the driver’s negligence caused the injury.”

Hence the language in the trolly example

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If I breach my duty of due care and injure you, I am liable

If I exercise the appropriate level of care but still injure you, I’m not liable

How is the standard of care determined? That is, how careful do I have to be to avoid liability, and who

decides? Is it negligent to drive 40 MPH on a particular road at a particular

time of day? What about 41 MPH? 42?

So under a negligence rule…

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Some settings: government imposes safety regulations that are also used as standard for negligence Speed limits for highway driving Requirement that bicycles have brakes Workplace regulations

Some standards are left vague “Reckless driving” may depend on road, time of day, weather… Common law focuses on duty of reasonable care Level of care a reasonable person would have taken (Civil law relies less on “reasonableness” tests, tries to spell out

what level of care is required)

How is the standard of care determined?

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Strict liability rule: plaintiff must prove harm and causation

Negligence rule: must prove harm, causation, and negligence

A little history Early Europe: strict liability was usual rule By early 1900s, negligence became usual rule Second half of 1900s, strict liability became more common again,

especially for manufacturer liability in American consumer products U.S. manufacturers now held liable for harms caused by defective

products, whether or not they were at fault

Strict liability versus negligence

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Harm

Causation

Breach of Duty


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Like with contract law, our main concern is with the incentives created by liability rules

So… what incentives are we interested in?

Next question

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Precaution

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The more carefully I drive, the less likely I am to hit you But, driving more carefully is also more costly to me Must be some efficient level of care

Similarly… Construction company can reduce accidents with better safety

equipment, better training, working shorter days, all of which cost money

Manufacturer can reduce accidents by designing/inspecting products more carefully – again, more expensive

Precaution

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Actions by both injurer and victim impact number of accidents

• drive carefully• drive drunk while texting

• careful quality control• cheap, hasty manufacturing

• install smoke detectors, other safety equipment

• save money

• drive slowly• speed like hell

• wear helmet and use light• bicycle at night wearing black

GREATER EFFORT TO PREVENT ACCIDENTS

LESS EFFORT TOPREVENT ACCIDENTS

“MORE PRECAUTION”“LESS PRECAUTION”

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Precaution: anything either injurer or victim could do to reduce likelihood of an accident (or damage done)

The next two questions should be obvious…

How much precaution do we want? What is efficient level of precaution?

How do we design the law to get it?

We will call all these things precaution

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Car hits a bicycle In real life: driver probably has insurance In real life: some damage to bicycle, some damage to driver’s car In real life: driver and bicyclist may not even know what the law is

We’ll simplify things a lot, by assuming… Only one party is harmed Parties know the law, don’t have insurance (for now) We’ll focus on one party’s precaution at a time

To answer these questions, we’ll introduce a very simple model of accidents

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Simple economic modelfor thinking about tort law

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Unilateral harm – just one victim

Precaution – costly actions that make accident less likely Could be taken by either victim or injurer We’ll consider both, but one at a time

Notation x – the amount of precaution that is taken w – the cost of each “unit” of precaution

so total cost of precaution is wx p(x) – probability of an accident, given precaution x

p is decreasing in x A – cost of accident (to victim)

so expected cost of accidents is p(x) A

Model of unilateral harmx level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accident

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Model of unilateral harmx level of precautionw marginal cost of precautionp(x) probability of an accidentA cost of an accident

Precaution (x)

$

p(x) A (Cost of Accidents)

wx (Cost of Precaution)

wx + p(x) A(Total Social Cost)

x* (Efficient Level of Precaution)

efficient precaution: minx { wx + p(x) A }

w + p’(x) A = 0

w = – p’(x) Amarginalsocial cost of precaution

marginal social benefit of precaution

x < x* x > x*

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A technical note (clarification)

We’re thinking of bilateral precaution, just “one at a time”

So really, xinjurer, xvictim, problem isminxi, xv { p(xi, xv) A – wi

xi – wv xv }

“Hold fixed” one party’s action and consider the other:minxi { p(xi, xv) A – wi

xi – wv xv } given xv (and v.v.)

This has same solution asminxi { p(xi, xv) A – wi

xi }

Our result will generally be “efficient given what the other guy is doing”

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We know what’s efficient Level of precaution that minimizes total social cost = wx + p(x) A

We’ll consider what happens if there is… no liability rule in place a strict liability rule a negligence rule

Effect of liability rules on precaution

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Benchmark: what happens without any liability rule?

Skip

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In a world with no liability… Injurer does not have to pay for accidents So, bears cost of any precautions he takes, but does not receive

any benefit Injurer has no incentive to take precaution Victim bears cost of any accidents, plus cost of precaution he takes (Victim precaution imposes no externality on injurer) Victim precaution will be efficient

Benchmark: No Liability

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Injurer’s private costis just wx Minimized at x = 0

Victim’s private costis p(x) A + wx Minimized at efficient

precaution level x = x*

So rule of no liability leads to efficient precaution by victims, no precaution by injurers


x

$

p(x) A

wx

wx + p(x) A

x*

Private cost to injurerPrivate cost to victim

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EfficientZeroNo Liability

Victim Precaution

Injurer Precaution

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Precaution – actions which make an activity less dangerous Driving carefully Wearing bright-colored clothing while bicycling

The amount we do each activity also affects the number of accidents I decide how much to drive You decide how much to bicycle

Liability rules create incentives for activity levels as well as precaution

Precaution isn’t the only thing that determines number of accidents

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With no liability, I’m not responsible if I hit you I don’t consider cost of accidents when deciding how fast to

drive… …and I also don’t consider cost of accidents when deciding

deciding how much to drive So I drive too recklessly, and I drive too much (or: if there is no liability, social cost of driving includes cost of

accidents, but private cost to me does not; driving imposes negative externality, so I do it too much)

So with no liability, injurer’s activity level is inefficiently high

With no liability rule…

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With no liability, victim bears full cost of accidents Greater activity by victim (more bike-riding) leads to more accidents Victim weighs cost of accidents when deciding how carefully to

ride, and when deciding how much to ride (Private cost = social cost) Victim takes efficient level of precaution, and efficient level of

activity

A rule of no liability leads to an inefficiently high level of injurer activity, but the efficient level of victim activity

What about victims?

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EfficientToo HighEfficientZeroNo Liability

Victim Activity

Injurer Activity

Victim Precaution

Injurer Precaution

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Wednesday, we’ll compare what happens under various

liability rules

Overall pretty good: median 84, average 81 (std dev 13)

Lot of dispersion

Not assigning letter grades till end of semester, but… to give a rough idea of how you’re doing, based on distribution of scores on first midterm, 80-90 roughly a B, 60-70 roughly a C

First Midterm

A-G P-ZH-O

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Econ 522 Economics of Law