Hazards Liability and Tort
Lecture 8
Outline
Another economic role for the government is regulating
hazards and risks
• Factory producing explosives (location & care in operation)
• Dangerous Dogs
• Food hygiene
• Driving
How much should we spent on precautions?
Outline
Regulating Hazards and Risks
• Factory producing explosives (location & care in operation)
• Dangerous Dogs
• Food hygiene
• Driving
How much should we spent on precautions?
Regulating Risk with Liability
• Liability for costs => incentives for precautionary spending.
Is this efficient?
Outline
Regulating Hazards and Risks
• Factory producing explosives (location & care in operation)
• Dangerous Dogs
• Food hygiene
• Driving
How much should we spent on precautions?
Regulating Risk with Liability
• Liability for costs=> incentives for precautionary spending.
Is this efficient?
Liability versus Ex Ante regulation
• Is it more efficient to regulate hazards ex ante? Or, should
we rely on incentives created by liabilities?
A Simple Model
Let us suppose:
w is the marginal cost of precaution (cost of inspecting
food hygiene)
A Simple Model
Let us suppose:
w is the marginal cost of precaution (cost of inspecting
food hygiene)
x is the amount of precaution (inspection).
A Simple Model
Let us suppose:
w is the marginal cost of precaution (cost of inspecting
food hygiene)
x is the amount of precaution (inspection).
p(x) is the probability that an accident occurs.
A Simple Model
Let us suppose:
w is the marginal cost of precaution (cost of inspecting
food hygiene)
x is the amount of precaution (inspection).
p(x) is the probability that an accident occurs.
A is the cost of an accident.
Total Costs
Total Costs
p(x)A = Expected Accident costs
x = Amount of precaution
Total Costs
Total Costs
wx = precaution cost
p(x)A = Expected Accident costs
x = Amount of precaution
Total Costs
Total Costs
Total Cost = p(x)A + wx
wx = precaution cost
p(x)A = Expected Accident costs
x = Amount of precaution
Total Costs
Total Costs
Minimum = Efficient amount of precaution
Total Cost = p(x)A + wx
wx = precaution cost
p(x)A = Expected Accident costs
x*
x = Amount of precaution
The same issue with slopes
Marginal Costs
Rate at which Accident costs
decrease
x = Amount of precaution
The same issue with slopes
Marginal Costs
w
Marginal cost of precaution
Rate at which Accident costs
decrease
x = Amount of precaution
The same issue with slopes
Marginal Costs
Minimum = Efficient amount of precaution
w
Marginal cost of precaution
Rate at which Accident costs
decrease
x*
x = Amount of precaution
Regulating Risk with Liability
We will examine the following 2 cases:
(1) Strict Liability
=> Injurer always liable for the costs of any accident.
Regulating Risk with Liability
We will examine the following 2 cases:
(1) Strict Liability
=> Injurer always liable for the costs of any accident.
(2) Liability Based on Negligence Rule
=> Injurer is liable for damages only if the court judges that
the injurer has been negligent.
1. Precautionary Incentives Under Strict
Liability
(Strict Liability => Injurer liable for accident damages
regardless of level of precaution taken).
The cost to the injurer =
Precautionary Costs + Accident Costs
1. Precautionary Incentives Under Strict
Liability
(Strict Liability => Injurer liable for accident damages
regardless of level of precaution taken).
The cost to the injurer =
Precautionary Costs + Accident Costs
As a result, costs imposed on victims are internalized by
the injurer (the injurer bears these costs too).
1. Precautionary Incentives Under Strict
Liability
(Strict Liability => Injurer liable for accident damages
regardless of level of precaution taken).
The cost to the injurer =
Precautionary Costs + Accident Costs
As a result costs imposed on victims are internalized by the
injurer (the injurer bears these costs too).
 Strict liability achieves the efficient level of precaution.
1. Precautionary Incentives Under Strict
Liability
(Strict Liability => Injurer liable for accident damages
regardless of level of precaution taken).
The cost to the injurer =
Precautionary Costs + Accident Costs
As a result costs imposed on victims are internalized by the
injurer (the injurer bears these costs too).
 Strict liability achieves the efficient level of precaution.
However, this is not true if victims can affect the
probability and size of the injuries!
2. Liability Under a Negligence Rule
Injurer is liable for damages only if the court judges the
injurer has been “negligent”.
2. Liability Under a Negligence Rule
Injurer is liable for damages only if the court judges the
injurer has been “negligent”.
Negligence  Less precaution is taken than the standard of
due care.
2. Liability Under a Negligence Rule
Injurer is liable for damages only if the court judges the
injurer has been “negligent”.
Negligence  Less precaution is taken than the standard of
due care.
Injurer bears all costs only if found negligent.
Otherwise the victim bears these costs.
2. Liability Under a Negligence Rule
SDC = “Standard of Due Care”
The incentives now depend on the SDC applied by the
court.
SDC too low => Marginal cost for injurer too low. Too little
precaution.
The injurer bears none of the accident costs if it has already
provided SDC.
If the SDC is too low:
Total Costs
Minimum = Efficient amount of precaution
Total Costs
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is too low:
Total Costs
Minimum = Efficient amount of precaution
SDC
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is too low costs are as before for
low levels of precaution:
Total Costs
Minimum = Efficient amount of precaution
SDC
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is low costs jump down at SDC:
Total Costs
Minimum = Efficient amount of precaution
SDC
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is too low don’t pay accident
costs if satisfy SDC:
Total Costs
Minimum = Efficient amount of precaution
SDC
Total Costs
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
On the other hand…
If the SDC is too high
 May get optimal precaution if the SDC is set just right.
However,
 May get excessive investment in precaution and an inefficient
outcome if it is unclear what the SDC is.
“Hand Rule” formulated in US Gov. versus Carroll Towing Company
applies a cost-benefit test on precaution to determine the SDC.
If the SDC is high:
Total Costs
Minimum = Efficient amount of precaution
SDC
Total Costs
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is high can get excessive caution:
Total Costs
Minimum = Efficient amount of precaution
SDC
Total Costs
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
If the SDC is high or can get efficient caution:
Total Costs
Minimum = Efficient amount of precaution
SDC
Total Costs
wx = precaution cost
Expected Accident costs
x*
x = Amount of precaution
Judge Learned Hand
“Since there are occasions when every vessel will break from
her moorings, and since, she becomes a menace to those
about her; the owner’s duty, as in other similar situations ,
to provide against resulting injuries is a function of three
variables:
(1) The probability that she will break away;
(2) The gravity of the resulting injury, if she does;
(3) The burden of adequate precautions.
Possibly it serves to bring this notion into relief to state in
algebraic terms: if the probability be called P; the injury L;
the burden B; liability depends upon whether
…B<PL.”(1947)
What he is saying…
If the party’s cost of preventing accidents (burden) is less
than the expected losses from accidents that party
should be deemed negligent.
Otherwise it is better for accidents to occur and the party to
compensate accordingly.
Comparing Strict Liability (SL) and
Negligence (N)
Who bears the costs of the accident differs.
N- Victim sometimes bears the cost.
SL- Injurer always bears the cost.
What are the Incentives?
Comparing Strict Liability (SL) and
Negligence (N)
Who bears the costs of the accident differs.
N- Victim sometimes bears the cost.
SL- Injurer always bears the cost.
What are the Incentives?
If victims cannot affect risks:
Both could be efficient but need to get SDC just right and
consistent for N to be efficient.
Comparing Strict Liability (SL) and
Negligence (N)
Who bears the costs of the accident differs.
N- Victim sometimes bears the cost.
SL- Injurer always bears the cost.
What are the Incentives?
If victims cannot affect risks:
Both could be efficient but need to get SDC just right and
consistent for N to be efficient.
If victims can affect risks:
• SL is inefficient as the victim has no incentive to exert precaution
and because injurer has excessive incentive.
• N could be more efficient as it provides incentives for victim
precaution too.
Ex Ante Regulation or Ex Post Liability
Liability
- Avoids potentially complex legislation.
Ex Ante Regulation or Ex Post Liability
Liability
- Avoids potentially complex legislation.
- Regulations may give inadequate weight to particular
and even unforeseen circumstances.
Ex Ante Regulation or Ex Post Liability
Liability
- Avoids potentially complex legislation.
- Regulations may give inadequate weight to particular
and even unforeseen circumstances.
- Regulation reduces the incentives to innovate in
precautionary technology.
Ex Ante Regulation or Ex Post Liability
Pro-Regulation
(1) Not everyone can bring court cases.
(Litigation costs, free rider problems in class actions,
causality is often hard to prove).
Ex Ante Regulation or Ex Post Liability
Pro-Regulation
(1) Not everyone can bring court cases
(Litigation costs, free rider problems in class actions,
causality is often hard to prove)
(2) Bankruptcy limits individual’s potential liability costs
If A > value of the firm.
=> F is the most the firm can pay
Total Costs
Minimum = Efficient amount of precaution
Total Costs
wx = precaution cost
Expected Accident costs=A p(x)
Actual Payout when accident = F p(x)
x*
x = Amount of precaution
Originally:
Total Costs
Minimum = Efficient amount of precaution
Total Costs
wx = precaution cost
Expected Accident costs=A p(x)
x*
x = Amount of precaution
If A > value of the firm.
=> F is the most the firm can pay
Total Costs
Minimum = Efficient amount of precaution
Total Costs
wx = precaution cost
Expected Accident costs=A p(x)
Actual Payout when accident = F p(x)
x*
x = Amount of precaution
Resulting in inefficient amounts of
precaution
Total Costs
Minimum = Efficient amount of precaution
Total Costs
wx = precaution cost
Expected Accident costs=A p(x)
Actual Payout when accident = F p(x)
x*
x = Amount of precaution
Bankruptcy under Liability
Bankruptcy
1. Reduces the incentives for taking care.
2. Firms may escape the consequences of litigation if they
go bankrupt while the trial proceeds.
3. Corporate restructuring can allow firms to escape
consequences of litigation.
Uncertainty about the legal process
If the legal process or the standard applied in the courts in
unclear or uncertain, then
This introduces
Uncertainty about the legal process
If the legal process or the standard applied in the courts in
unclear or uncertain, then
this introduces
(1) a potential risky decision for claimants – benefiting
injurers and reducing the incentives for care.
Uncertainty about the legal process
If the legal process or the standard applied in the courts in
unclear or uncertain, then
this introduces
(1) a potential risky decision for claimants – benefiting
injurers and reducing the incentives for care.
(2) a potential of escaping even when negligent again
reducing the incentives for care.
Ex Post and Ex Ante Together
Often these may be complementary rather than substitute
policy choices.
If injurer may not be held liable, or does not correctly asses
the probabilities of being held liable,
then a little ex ante regulation may push him in the right
direction!