Law & Eco ppt.pdf

Law & Economics Unit 1: Concepts of Law & Uses of foundations of Economics Miceli: Ch1 Cooter & Ulen: Ch2 What is Law & Economics? Interdisciplinary field - examines the relationship between legal systems and economic principles. Application of economic theory (esp. mi...

Law & Economics Unit 1: Concepts of Law & Uses of foundations of Economics Miceli: Ch1 Cooter & Ulen: Ch2 What is Law & Economics? Interdisciplinary field - examines the relationship between legal systems and economic principles. Application of economic theory (esp. micro) to the analysis of law. Why Economists study law? ○ Extensive material for evaluating theories of rational behaviour ○ Both fields focus on incentives; rational decision-makers act in self- interest s.t. constraints Economic approach to law: rational individuals view legal sanctions (monetary damages, fines, prison) as implicit prices guiding behaviour. Law creates incentives for people to behave in certain socially desirable ways 2 Oliver Wendell Holmes: “Prediction theory of law”; “Bad Man” theory “Bad Man”: rational calculator; stretches the limits of law, breaks it if benefit > cost. Holmes: law should be defined as a “prediction” of how the courts behave “Bad man” cares little for ethics/morality; instead cares simply about staying out of jail & avoiding the payment of damages. Good conduct- not because it is right, but self-interest to avoid a legal sanction Understanding the law requires considering material consequences While many obey laws out of morality (sense of rightness, unaffected by legal rules), the focus on those constrained by law reveals its incentive effects 3  Economic Analysis of Law Positive Analysis Normative Analysis Explains how people actually respond to Prescribes how the law can be laws/ legal sanctions, asking questions like: changed/improved to better achieve Do longer prison sentences deter crime? the efficiency goal Does death penalty reduce murder rate? How healthcare, education system be Asserts that the common law (body of made more efficient? law created by judicial precedents) has Assumes that efficiency should be actually evolved, without conscious reflected in the law & legal rules planning, to reflect economic logic & should be modified if it is not reasoning achieved Efficiency is a social goal actually reflected in the law 4 Efficiency: valid norm for evaluating law? Critics argue against judging laws solely on economic efficiency, advocating for fairness and justice Distributive justice relates to wealth distribution, while efficiency minimizes resource waste Kaplow & Shavell propose social welfare as the basis for legal policy evaluation, emphasizing well-being over fairness. Argue against narrow efficiency concepts (e.g. wealth maximization) since they exclude factors that may affect well being (e.g wealth distribution) Despite objections, efficiency often serves as a practical proxy for welfare in legal contexts, especially in economic legal questions 5 Pareto Efficiency Pareto efficient/Pareto optimal allocations: 1. An allocation A is Pareto Superior to allocation B if: both individuals are at least as well of under A as compared to B, and at least one individual is strictly better off 2. A is said to Pareto efficient/optimal if there exists no other allocation that is Pareto superior to it Reallocations are allowed only if neither party is made worse off; any change should be consensual Weaknesses: 1. Pareto efficiency lacks uniqueness; infinite allocations possible (see UPF) 2. It can lead to non-comparable allocations, complicating legal policy evaluations. Does not permit a comparison of changes that produce both gainers and losers 6  Utility Possibility Frontier: max level of utility that one individual can achieve for every possible level of utility attained by other individual, given resources & technology. Points on/inside UPF: all feasible allocations Is allocation A PO? Area ABC - allocations pareto superior to A (how?) Points on BC - pareto optimal (efficient); no feasible reallocation that can make both better off Pareto efficient points are non-comparable with each other; Pareto efficiency criterion cannot rank them Allocation A vs D? D is PO; A is not. Still non- comparable. Reason? PO defn depends on initial allocation 7 Kaldor-Hicks Efficiency (Potential Pareto Efficiency) Relaxed notion of pareto criterion; addresses the shortcoming of non-comparability Observe movements: B to C? A to D? - Pareto criterion could be satisfied if P2 (gainer) is made sufficiently better off so that he can fully compensate P1 (loser) & still realise net gain - Gainers gain more than what losers lose - Allocation C PS to B ; Allocation D PS to A 8  Movements where full compensation possible (not paid): KH efficient; if paid: truly pareto efficient KH efficiency equivalent to wealth maximization or cost- benefit analysis; changes in policy are efficient if aggregate gains > losses Cost minimisation/Wealth maximisation: principle of marginal analysis (outcome optimal if marginal gains = marginal costs) 9 Consensual vs Non Consensual Exchange KH efficiency addresses Pareto's noncomparability but lacks consensuality due to actual losers Consent guarantees mutual gains; basis for efficiency (satisfied Tradeoff: under pareto efficiency) Market failure (e.g. due to externalities) - all gains from trade not exploited; need govt intervention/legal obligations to correct it Tradeoff highlights the need for government intervention which often creates winners & losers Lose from one policy; gain in other - net: everyone gains as agg wealth increases (overall pie size ↑; average slice ↑). Implied consent for use of KH criterion replaces actual consent under Pareto Economic approach to law focuses on judge-made law, minimizing systematic losers by insulating judges from political influences 10 Coase Theorem (Ronald Coase) Prior to Coase: Externalities internalised only by govt intervention (e.g. tax/ ne on polluter); Coase emphasised the role of bargaining & transaction costs Example: Consider a farmer and rancher who occupy adjoining parcels of land; rancher’s cattle strays onto farmer’s land - crop damage 11 fi Suppose MB (MR-MC) to rancher = $3.5; joint value (ranching & herding) max at h * = 3 since pro t (ranching) > cost (crop damage); at 4 - cost higher - Suppose one person owns both: internalise both bene t & cost; choose h * = 3 - Separate owners: rancher ignores crop damage; choose max possible h( = 4) > h * So, govt intervention needed to make rancher internalise farmer’s loss (e.g. tax on ranching, allow farmer to le nuisance suit) Consider: in the absence of liability, rancher adds 4th steer; pro t: $3.5 (ignore $4 damage); Possibility of bargaining (both better o ) ⟹ h * = 3 (e cient size) (how?) - farmer o ers to pay rancher $3.75 (to not add 4th steer); accept since $3.75 > 3.5 - Farmer saves on $4 damages by paying $3.75 12 ff fi fi ff fi ffi fi Coase Theorem states that the efficient allocation of resources will be achieved in the presence of externalities provided that property rights are well-defined and all affected parties can negotiate with each other at low cost. Illustrates how e cient outcomes can be achieved through bargaining, regardless of liability assignment. A rancher and farmer can negotiate to reach an e cient herd size, demonstrating that private agreements can resolve externalities. Regardless of whether rancher is liable for crop damage, herd size will be the same 13 ffi ffi  Implications of Coase Theorem: - Suggests that e ciency and distributional justice can co-exist. - Herd size invariant to liability assignment, income distribution is not. When rancher liable, make damage payments to farmer; if not liable, farmer pays rancher to not exceed herd beyond e cient size. So, liability assignment variations can be used to change wealth distribution w/o a ecting resource allocation. - When CT conditions met, judges can pursue distributional justice w/o sacri cing e ciency. - If high bargaining costs, private agreements unlikely & liability assignment dictates nal resource allocation. So, liability assignment rule crucial for e ciency. Leads to a debate on whether laws should be rigid or exible, balancing predictability and discretion for judges. - In low-transaction-cost scenarios, rules su ce, but in high-cost environments, legal exibility becomes essential for e ciency. 14 fl ffi ffi ffi ffi ff fl ffi ffi fi fi The “Law” in Law & Economics Primary sources of law (US): - Constitution - Legislature - Judiciary - enacts laws as by-product of its role in resolving legal disputes Common law - body of “legal precedents” that have emerged from judicial decisions. The undirected nature of this body of law lends itself to economic analysis because it has certain “market-like” properties. Interplay between law and economics reveals complex dynamics that shape societal outcomes. Understanding these concepts enhances our ability to evaluate legal frameworks and their implications for economic behaviour. 15 Game Theory GT studies strategic interactions between individuals/groups, where the outcome for each player depends not only on their own decisions but also on the decisions made by others. Way to model & analyse situations where players (individuals, rms, countries, etc.) make decisions that are interdependent, often with con icting interests. Deals with any situation in which strategy is important. Strategy - plan for acting that responds to the reactions of others. Enhances our understanding of legal rules & institutions. Specify: 1. Players 2. Strategies of each player 3. Payo s to each player for each strategy 16 ff fl fi Prisoners’ Dilemma Classic example in game theory; illustrates the con ict between individual rationality and collective bene t Setup: - 2 suspects apprehended by police; placed in separate rooms, can’t communicate; - facing charges with di erent outcomes based on their decisions - 2 strategies: confess/keep quiet - Payo matrix: Strategic form of the game; Decision tree: Extensive form - If both confess, they get 5 years each. If one confesses and the other doesn’t, the confessor gets 6 months, and the other gets 7 years. If both keep quiet, they get 1 year each. 17 ff ff fi fl Prisoners’ Dilemma Payoff matrix/Strategic form Decision tree/Extensive form 18 Prisoners’ Dilemma How will Suspect 1 select optimal strategy? (Same as S2 as game symmetrical) Observe Payo matrix: - If S2 confesses, what should S1 do? confess? (why?) - If S2 keeps quiet? S1 confess (why?) S1 will always confess! ⟹ dominant strategy Dominant Strategy: Optimal/best move for a player is the same (confess) regardless of what the other does. Confessing is the dominant strategy for each player. So, both confess; spend 5 years in prison. Solution (both confess) - equilibrium 19 ff Prisoners’ Dilemma Nash Equilibrium (NE): A situation where no player can bene t by changing their strategy while the other players keep theirs unchanged. It represents a stable state of the game where no one has an incentive to deviate from their chosen strategy. Both suspects confessing is a Nash equilibrium; neither can do better by changing their strategy. (But is it pareto e cient?) While NE is stable, it is not the best outcome for either suspect. Shortcomings: - some games have no NE; some have several NE - correspondence b/w NE & Pareto E ciency - not necessary 20 ffi ffi fi When both confess, get 5 years in prison. Is it possible for both players to be better o ? Yes! Both keep quiet (cell 4); 1 year in prison ⟹ Pareto e cient outcome; Pareto E ciency: NE is not Pareto-e cient; both could be better o if they keep quiet (1 year each). Also, PE outcome is not NE (why?) (check!) Con ict between individual rationality and collective welfare 21 fl ffi ff ffi ffi ff Repeated Games: The same game is played multiple times by the same players according to the same rules. Impact on Strategy: Fixed number of repetitions: Cooperation unravels, leading to confession every time Inde nite number of repetitions: Cooperation may emerge through strategies like tit-for-tat 22 fi Fixed Repetition Example: 10-round game; Players must consider their strategy across all 10 games, not just one. Final Round (Game 10): Both players know - no future game to consider, so strong incentive to confess. If one confesses & other stays silent, confessor will get a lighter sentence & silent one will su er heavier penalty. Knowing this, both players likely to confess in the nal game. Game 9: Now, if both players know they will de nitely confess in Game 10, they treat Game 9 as if it were the last game. The same logic applies, leading them both to confess in Game 9 as well. Earlier Rounds (Games 8, 7, etc.): This logic continues to unravel backward from Game 10 to Game 9, then to Game 8, and so on. Each player realises that the optimal strategy in each game is to confess, as they anticipate the confession in the subsequent rounds. 23 fi ff fi  Creates a chain reaction where each preceding round becomes the new " nal" round in the players' eyes, leading to the same outcome: defection Backward reasoning process - backward induction, leads to conclusion that in a xed number of repeated games, rational players will defect in every round, even if it might seem like cooperation could be bene cial in the short term. The game "unravels," and the possibility of cooperation disappears. Inde nite Repetition Example: Potential for sustained cooperation Optimal strategy - Tit-for-tat: replicate the other player’s previous action Application - Debtor-Creditor Relationships: In good times, it resembles an inde nite game with trust and cooperation In insolvency, it becomes a xed game, leading to mistrust and con ict - debtor may hide assets; creditor may try to seize them for resale to recover losses 24 fi fi fi fi fi fl fi Implications for Law: - Understanding strategic behaviour is crucial for crafting legal rules and institutions - Prisoner’s Dilemma highlights the tension between individual and collective interest - Game theory concepts like Nash Equilibrium and Pareto E ciency have broader applications, including in law - Repeated interactions can lead to di erent strategic outcomes, with important implications for legal and economic behaviour 25 ff ffi General Equilibrium & Welfare Economics - Focuses on how individual decisions by consumers and rms impact overall societal welfare. - Addresses philosophical and policy-related questions, including e ciency vs. fairness, the role of government, and just distribution of resources. GE & E ciency Theorems: - General equilibrium occurs when all markets simultaneously reach equilibrium, leading to both productive and allocative e ciency. - Productive e ciency: rms seek the best combination of inputs to lower their costs of production. - Allocative e ciency: economic resources are distributed in a way that produces the highest consumer satisfaction relative to the cost of inputs. - MB=MC (for all G&S) - Understanding the conditions for general equilibrium is crucial for evaluating markets and public policy recommendations. 26 ffi ffi ffi fi ffi fi ffi Market failure - Monopoly Market failure occurs when the free market, operating on its own, fails to allocate resources e ciently, leading to a loss of economic & social welfare. Four sources of Market failure: 1. Monopoly & Market Power. 2. Externalities. 3. Public Goods. 4. Informational Asymmetries 1. Monopoly and Market Power: Monopolies (e.g. in o/p market, collusion, monopsony) lead to ine ciencies where prices are too high, and output is too low. 27 ffi ffi Monopoly: Pm > Pc & qm < qc Public policies to address monopoly include replacing with competition wherever possible (rationale for Anti trust law) or regulating prices charged by monopolies, esp. in cases like natural monopolies (e.g. public utilities - allowed to continue s.t. govt regulation). 28 2. Externalities Market exchanges are typically voluntary & mutually bene cial, where parties capture all bene ts & bear all costs. Externalities occur when the bene ts or costs of an exchange spill over to third parties not directly involved in the exchange. - External Bene ts: Positive e ects on third parties (e.g., a beekeeper's bees pollinating a neighbouring orchard). - External Costs: Negative e ects on third parties (e.g., air or water pollution from a factory). Consider a factory upstream from a city that dumps toxic waste into a river. The downstream city's residents incur additional costs to clean the water or source alternative water, a cost they did not agree to bear. Market Failure occurs because the factory does not pay for the harm it causes, leading to overproduction and excessive pollution. 29 fi fi ff ff fi fi PMC vs SMC Private Marginal Cost (PMC): Marginal cost of production borne by the factory. Social Marginal Cost (SMC): Total cost, including both the private cost & external costs imposed on third parties. SMC > PMC at every output level. Vertical di erence: external marginal cost. As production increases, external costs increase, leading to greater divergence between SMC and PMC. Firm: max pro ts where Pc = PMC (at qp) Socially optimal output level where Pc = SMC (at qs) : re ects true cost to society, including externalities. qp > qs 30 ff fi fl Public Policy to address Externalities - The key challenge is to create policies that make the rm consider the external costs it imposes, e ectively internalising the externality. - Policies should aim to shift the rm’s operation from the PMC curve to the SMC curve, leading to a socially optimal outcome. - Internalising the externality ensures that the rm restricts its output to the level that maximises overall social welfare, not just private pro ts. 31 ff fi fi fi fi 3. Public Goods Public good is a commodity characterised by: - Non-rivalrous Consumption: One person's consumption of the good does not reduce its availability to others. - Non-excludability: It is di cult or impossible to exclude nonpaying consumers from using the good, making it unpro table for private rms to supply it. National Defense: Hypothetical scenario: National defense provided by private companies. Customers pay an annual fee for protection against foreign invasion. 32 ffi fi fi  Non-rivalrous Consumption: If one person purchases protection, nearby non-purchasers also bene t indirectly (e.g., if their neighbour buys protection, they might also be protected). Leads to a free-rider problem where many individuals may choose not to pay, hoping to bene t from others who do. Non-excludability: It would be nearly impossible for private rms to exclude non-paying individuals from bene ting (e.g., identifying garments or property markings could be counterfeited). As a result, private companies would struggle to convince enough people to pay for the service. Due to free-rider problem and the di culty in excluding nonpaying bene ciaries, private rms are unlikely to provide an adequate level of public goods. In case of national defense, if left to private companies, too little of this essential service would be provided. 33 fi fi fi fi ffi fi fi Public Policy solutions for Public Goods Government Subsidies: - Government can subsidise the private provision of public goods, either directly or indirectly through the tax system. - Example: Subsidising research in basic science. Government Provision: - Government can directly provide the public good and fund it through compulsory taxation. - This is how national defense is typically provided by governments, ensuring adequate supply. 34 4. Severe Informational Asymmetries Informational asymmetries occur when one party in an exchange has more or better information than the other, leading to an imbalance that can disrupt market e ciency. Sellers Knowing More than Buyers: - Car Sales: The seller knows more about the car's condition than the buyers. - Bank Agreements: The bank has more knowledge about the legal consequences of a depository agreement than the customer. Impact on Markets: - Voluntary Exchange Mechanisms: Some asymmetries can be addressed through mechanisms like warranties, where the seller guarantees product quality. - Severe Asymmetries: When the information imbalance is too signi cant, it can prevent optimal market exchanges, leading to market failure. 35 fi ffi 4. Severe Informational Asymmetries Government Intervention: Example: In real estate, buyers may not know about latent defects in a home, such as termites or foundation issues. This could lead to ine cient market functioning, with buyers overpaying or avoiding purchases. Policy Response: Many states require sellers to disclose known latent defects to prospective buyers. If not disclosed, sellers may be liable for correcting the defects. 36 ffi Potential Pareto Improvements/KH E ciency Pareto criterion only recommends changes where at least one person bene ts without making anyone else worse o. This requires explicit compensation to the losers, which can hinder public policy due to the need for unanimous consent. Kaldor-Hicks E ciency: A change is considered a potential Pareto improvement if the gainers gain more than the losers lose. Compensation to losers does not have to be made but must be possible in principle. Technique of C-B analysis. Cost-Bene t Analysis: It involves undertaking projects when bene ts exceed costs, implying that gainers could theoretically compensate losers. 37 fi ffi ff ffi fi fi Potential Pareto Improvements/KH E ciency Example: Manufacturing Plant Relocation (town A to B): Pareto Criterion Application: The gainers from the plant’s move would need to compensate the losers to the extent that the losers are indi erent between the plant staying or moving. Kaldor-Hicks Criterion Application: The move is justi ed if the gainers bene t more than the losers su er, even if no compensation is provided. 38 fi ff ffi fi ff Economics of Tort (Accident) Law/Liability Rules Miceli: Ch 2 & 3 Pal: Ch 1 & 3  Economic Model of Tort Law - The economic model of tort law aims to create incentives for parties involved in risky activities to minimise the costs associated with these risks. - a.k.a ”model of precaution," focusing on risk reduction and cost minimisation. Total accident costs consist of: - Damages su ered by victims (measured in monetary terms) (e.g. medical expenses, lost wages, pain and su ering, property damage) - Costs of precautions taken by both injurers & victims (e.g. cost of safety equipment, training, engineering design changes) - Administrative costs of the tort system (e.g. cost of lawyers, judges, and court sta , as well as the cost of discovery and trial) 40 ff ff ff What is a Tort? - Tort law deals with accidental injuries, including personal injuries, product liability, workplace accidents, medical malpractice, & environmental accidents. - Risk is inherent in many socially bene cial activities, but cost-justi ed precautions should be taken to minimise resulting costs. Social functions of Tort Law: - Compensation: Compensating victims for their injuries. - Deterrence: Deterring unreasonably risky behaviour through monetary incentives for those engaged in risky activities. The economic approach emphasises optimal deterrence over compensation. 41 fi fi Filing a Lawsuit Tort law is a private remedy for accidental harms where the victim (plainti ) sues the injurer (defendant). To recover damages, the plainti must prove: - Sustained damages - The defendant was the cause of those damages In some cases, proving fault is also necessary. 42 ff ff Causation in Tort law Cause-in-Fact: Established using the "but-for" test: The plainti must prove that "but- for" the defendant's action, the harm would not have occurred. Challenges include cases with multiple causes or extremely remote causes. Proximate Cause: Even if cause-in-fact is established, the connection between the injurer's action and harm cannot be too remote. The "reasonable foresight" test is often used to determine proximate cause. 43 ff Types of Liability Rules No Liability: The victim bears all costs themselves. Example: “Caveat emptor” ("buyer beware") in product liability. Strict Liability: The injurer must pay all damages once causation is established. Negligence Rule: Liability is shifted from victim to the injurer only if the injurer is found negligent/at fault. Negligence: breach of a legal duty to take reasonable precautions. If injurer is judged to have satis ed the duty, he is absolved from liability. Negligence rule - hybrid of no liability & strict liability, based on the injurer's level of precaution. 44 fi Economic Model of Accidents: The Model of Precaution Designed to minimise the total costs associated with risky activities by assigning liability through legal rules. Types of Precaution Models: - Unilateral Care Model: Only the injurer can invest in precautionary measures to reduce the likelihood and severity of damages to the victim. - Bilateral Care Model: Both the injurer and the victim can invest in precautionary measures. 45  Focus on cost of precaution and damages, initially ignoring administrative costs ( ling suits, conducting judicial proceedings, etc.) Assumptions: - Injurers do not su er damages themselves. - Analysis initially disregards whether engaging in risky activity is bene cial or at what level it should be undertaken. - Injurers & Victims are risk-neutral. Socially e cient level of precaution: Level that would be chosen by a social planner to minimise total costs. Used as benchmark to examine the incentives created by actual legal rules. 46 fi ffi ff fi Unilateral Care Model Notation: x : Dollar investment in precaution by the injurer. p(x) : Probability of an accident. D(x) : Dollar losses (damages) su ered by the victim. Assumptions: - Both p(x) and D(x) decrease as x increases ⟹ greater precaution reduces the likelihood and severity of an accident. - Expected damages : p(x)D(x) also decrease with increased precaution, but at a diminishing rate, re ecting diminishing marginal bene ts. - Injurers prioritise the most e ective precautionary measures rst. 47 fl ff ff fi fi UCM - Social Optimum Social OP: Minimise the sum of cost of precaution & expected damages min x + p(x)D(x) x * : cost minimising level of care (min pt. of TC curve. Below x * : additional care reduces TC, while beyond x * additional care increases TC. At x * : slope of x curve (MC of care $1) = (-) slope of p(x)D(x) curve (MB of care; ↓ expected damages) 48 UCM - Actual Care Choice by Injurer : x? No liability Strict liability Negligence rule Injurer minimises their Injurer is liable for victim’s The injurer owes a duty of expenditure on precaution full costs, leading them to reasonable care to potential victims. (sets x=0) because the choose the socially optimal If injurer meets "due standard" of victim’s damages are care level x*. care, they avoid liability & only pay external to them. their own precaution costs. If injurer Liability functions like a fails to meet this standard, they are Total costs not minimised. Pigouvian tax, internalising fully liable. the externality of the victim’s damages and Negligence rule is a combination of no aligning the injurer’s costs liability & strict liability, with x* as with social costs. the switch point. 49 UCM - Negligence x ̂ : Due care standard ̂ - If accident occurs & injurer is judged by the court to have met this duty (x ≥ x), they avoid all liability, but still bear cost of precaution. ̂ they are fully liable for the victim’s - If injurer fails to meet this duty (x < x), damages. - Negligence - combination of no liability & strict liability. "Switch point" between these two extremes determined by "due standard of care." Due standard : "reasonableness standard,” - level of care a reasonable person would undertake under similar circumstances faced by the injurer. In economic terms, reasonableness standard is equated with efficient care, i.e. x ̂ = x * 50 UCM - Negligence x * : switch point b/w strict & no liability; then Injurer’s problem under Negligence: Minimise: x if x ≥ x * (avoid liability if meets x * ) x + p(x)D(x) if x < x * (also pay victim’s damages if fails) Injurer's costs coincide with social costs when they take less than due care x < x * , but these costs drop to just the precaution costs when they meet or exceed the due care standard x ≥ x *. Lowest point at x * 51 UCM - Strict Liability vs Negligence Both strict liability & negligence lead to e cient injurer care in UCM. But administrative costs? Administrative Costs: - Cost Per Case: Strict liability cheaper to apply because plainti s only need to prove causation, not fault. In negligence, need to prove both. SL - less fact nding & cheaper trials - Number of Lawsuits: Negligence may result in fewer lawsuits because victims must also prove fault, and injurers have strong incentives to meet the due standard. Overall Litigation Costs: Comparison between strict liability & negligence is ambiguous, as strict liability may lead to less costly suits but more of them, while negligence may result in fewer suits but with higher individual costs. 52 ffi ff fi Additional Factors: 1. Errors in calculating Due Standard: If court errs in setting due standard under negligence (x ̂ ≠ x * ), may lead to ine cient care choice. Issue doesn’t arise under strict liability, as court doesn’t need to set due standard. 2. Errors in Measuring Victim’s Damages: Can lead to ine cient care under strict liability. Under negligence, such errors are less likely to distort injurer’s care choice as long as the errors are not large. Discontinuity in injurer’s costs insulates his care choice from small errors in damage estimation. 3. Goal of compensating victims which SL accomplishes but Negligence does not. 53 ffi ffi Bilateral Care Model Both victim & injurer can take actions (invest in care) to reduce probability & severity of accident. Examples: - Car Accidents: Driver's Care: Drive safely, follow tra c rules. Pedestrian's Care: Use crosswalks, follow signals. - Product Liability: Manufacturer's Care: Provide safe products & instructions. Consumer's Care: Follow safety instructions, use properly. - Medical Malpractice: Doctor's Care: Perform surgery well, proper hygiene, give recovery instructions. Patient's Care: Follow pre- and post-surgery guidelines (e.g. avoid certain foods, activities) - Workplace Safety: Employer's Care: Provide a safe work env. & training. Employee's Care: Follow safety protocols, wear protective gear. - Sports Injuries: Coach's Care: Train athletes properly, enforce safety rules. Athlete's Care: Follow training, use protective equipment. 54 ffi  Bilateral Care Model Notation: y : Dollar investment in precaution by the victim. p(x, y) : Probability of an accident. D(x, y) : Damages su ered by the victim if accident occurs. Expected damages p(x, y)D(x, y): decreasing in both x & y Social OP: min x + y + p(x, y)D(x, y) E cient Care Levels: Optimal care levels are denoted as x* (injurer) and y* (victim), both assumed positive. 55 ffi ff BCM - Actual Care Choice? No Liability & Strict Liability Symmetry: In BCM, no liability for the injurer equivalent to strict liability for the victim & vice versa. No liability Strict liability Injurer takes no care (x=0) since they bear none of Victim, fully compensated, takes no care the damages. Victim bears full responsibility & (y=0). Injurer takes full responsibility & knows x=0, choose y > y* to compensate for chooses x > x* to compensate for victim’s injurer’s inaction. failure to take care. Neither rule leads to e cient outcome as one party always avoids responsibility, creating moral hazard problem. Bilateral responsibility: E ciency possible if injurer is assessed full amount of victim’s damages, but victim does not receive this payment. Injurer treats rule as SL & victim - NL. Mimics Pigouvian tax, where payment is a deterrent, but the victim is not compensated. But real-world liability rules don’t follow this structure due to compensatory function of tort law. 56 ffi ffi  BCM - Negligence Injurer can avoid liability by meeting due standard (x ̂ = x * ). If choose x ≥ x * , avoid liability regardless of victim’s care choice. So meets due standard, x*. Victim anticipates this (& expects to bear own losses); so choose y to: min y + p(x * , y)D(x * , y). (choose y*) Socially optimal outcome-Nash Equilibrium: Both Injurer & Victim act e ciently in eqbm. - Injurer meets the care standard (x*) to avoid liability. - Victim internalises full cost of own losses & chooses e cient level of care (y*). E ciency: Negligence rule induces bilateral responsibility by holding both parties accountable for damages they can control. Resolves ine ciencies seen in SL & NL rules. Limitations: - Victim not compensated for damages, potential con ict b/w compensatory & deterrence functions of tort law. - Real-world deviations from this model (uncertainty about due standard, di erent care costs, limited injurer wealth), may lead to parties being negligent even under negligence rule. 57 ffi ffi fl ffi ff ffi The Hand Rule Formulated in United States v. Carroll Towing Co. (1947) case by Judge Learned Hand. Case: - A barge broke loose from its moorings in a New York harbour. It collided with other vessels, causing damage to both ships & cargo. No bargee (attendant) was on board when the accident occurred. - Issue: Was barge owner negligent for not having an attendant on board? 58 The Hand Rule Court found the barge owner negligent for failing to provide an attendant. Hand Rule formula was developed to assess negligence. Barge owner was negligent because the burden (B) of having an attendant was lower than the expected damages (P × L). Liability depends on whether the burden of care (B) is less than the probability of an accident (P) multiplied by severity of injury (L), i.e., whether B < PL. B: Burden or cost of adequate precautions. P: Probability of harm (accident). L: Severity of the resulting injury. 59 Hand Rule - Interpretation Hand Rule aligns with economic model, where x* is the level of injurer care that minimises (precaution costs + expected damages). At x*, MC of care = MB (reduced damages). If B: MC of care ; PL : marginal reduction in accident costs; then injurer negligent i B < PL (range over which x < x * ). Marginal Hand Rule: Hand Rule applies marginal analysis (i.e. MC vs MB). Real-world cases: care in discrete bundles (not continuous), making marginal analysis more complex. Hand Rule helps determine whether an injurer’s care is efficient or whether they are negligent based on marginal costs & benefits. 60 ff Reasonable Person Standard Till now, all injurers - identical costs of care ($1/unit). Reality: injurers & victims - di erent costs of care due to: varying abilities, re exes, or strengths. Optimal care level for each individual is cost-minimising & depends on speci c unit cost of care (cj). min cj x + p(x)D(x) Individuals with higher MC of care (cj) will have lower optimal care levels, given equal MB of care across injurers. Example: 3 injurers c1 < c2 < c3 ; Corresponding cost-minimising care levels will be: x1 * > x2 * > x3 *. If taking care is cheap, care more. If taking care is expensive, take less care. Cheaper for someone to take care (c ↓), more care they should take, since bene t of reducing probability of accident outweighs cost of taking care. So, they should be held to higher standards of care. 61 fl fi fi ff  Reasonable Person Standard Law does not individualise standards based on each person’s speci c cost of care. Instead, a single uniform standard is applied called "reasonable person" standard. De ned as a personi cation of a community ideal of reasonable behaviour, determined by the jury’s social judgment. Negligence: failure to do what reasonable person would do in similar scenario. Economically, single standard does not minimise overall accident costs when injurers have di erent MC of care. Administrative costs of individualising care standards for each person are too high, making a single standard more practical. 62 fi ff fi fi  Two ine ciencies from setting a single care standard when injurers have di erent care costs: Ine ciency 1: Below-Average Cost of Care: Ine ciency 2: Above-Average Cost of Care: - Individuals with below-average MC of care - Individuals with cost of care slightly above- have a lower due standard than their average, & standard less than average optimal individual level (x * < xj * ) (x * > xj * ) will increase care up to due - No incentive to increase care above x*, standard (x*). even though doing so would reduce social - Happens since negligence rule creates costs. strong incentive for injurers to comply with - Under negligence rule, avoid liability by standard to avoid liability. meeting due standard & gain nothing by - However, over-investment in care exceeding it. increases social costs, as last dollar spent - So, take too little care. on care reduces expected damages by less than one dollar. 63 ffi ffi ffi ff Reasonable Person Standard Third Group: E cient Care Takers: - Injurers: cost of care is so high, & ind. standard so low relative to x*, nd it too costly to raise their care level up to x*. - Choose individual care level (xj * ) and are judged negligent. - For this group, negligence rule equivalent to strict liability. Overall: - Some injurers underinvest in care, some overinvest, and some invest e ciently but are found negligent. - Leads to mixed results in accident prevention under a single standard compared to rule with individualised standards or strict liability. - But, total costs higher due to the ine cient care choices by injurers who take too much/too little care ( rst two groups). 64 fi ffi ffi fi ffi Reasonable Person Standard Injurers with c < c1 take too little care. Injurers with c1 < c < c2 take too much care. Injurers with c > c2 take e cient care but are found negligent. 65 ffi Contributory Negligence Legal doctrine - Victims must also meet a standard of care to recover damages for their injuries. Can be used as a defense by injurers. Ensures that victims cannot claim damages if they themselves failed to exercise due care, even if injurer was also negligent. First introduced in Butter eld v. Forrester (1809): Plainti was injured when his horse collided with an obstruction placed negligently by the defendant. Court ruled that plainti could not recover damages due to his own failure to use due care. Two cases: 1. Negligence with Contributory Negligence 2. Strict Liability with Contributory Negligence 66 ff fi ff Negligence with Contributory Negligence Both injurer & victim must meet e cient standards of care (x* injurer ; y* victim). Liability Assignment: Victim’s Negligence: If victim fails to meet y*, cannot recover damages, even if injurer is negligent. Injurer’s Liability: If victim meets y* (or y ≥ y * ), Injurer can avoid liability by meeting x*, remains liable if they are negligent. Lower left quadrant (both negligent): SN: Injurer liable, regardless of victim's care level CN: Victim liable if they were also negligent. Liability assignment under Negligence with Contributory Negligence Other quadrants: liability assignment remains same under both rules. 67 ffi  Contributory Negligence E ciency: Adding CN doesn’t a ect e ciency of negligence rule, provided both due standards are set correctly. Injurer: If injurer expects victim to meet y*, he chooses x* (similar to SN) (but if expects victim to be negligent, faces no liability, choose x=0). Victim: If victim expects injurer to meet x*, he chooses y* (similar to SN). In Nash eqbm, both choose e cient care (x* & y*). CN does not distort incentives or a ect the allocation of liability in equilibrium. Under both SN & CN, victim bears own liability in e cient eqbm. But, CN costlier to administer than SN, as it requires evaluating two standards of care instead of just one. 68 ff ffi ffi ff ffi ffi Strict Liability with Contributory Negligence Under SL with CN, only victim’s care standard matters. “Negligence rule for victims”. Nash Eqbm: Victim chooses due care to avoid liability. Injurer, who is thus strictly liable, chooses e cient care to minimize costs. Setup mirrors NE in SN but with reversed roles of victim & injurer. 69 ffi Strict Liability with Contributory Negligence SL with CN achieves bilateral e ciency in eqbm, similar to other negligence rules. But di ers regarding liability assignment. In e cient eqbm, injurer bears the damages, victim avoids liability by meeting care standard. Distributional Grounds: SL with CN may be preferred when favouring victims over injurers for policy reasons, without distorting incentives for e cient care. Applicable in context of products liability. 70 ffi ff ffi ffi  Sequential Care Accidents Simultaneous care choice (based on expectations) vs Sequential? SCA: Accidents where injurer & victim make their care choices in sequence. 2nd party can observe rst mover’s actual care choice before acting. 1. Injurer moves rst: (Butter eld v. Forrester (1809)) Injurer negligently placed obstruction in the street. Victim (rider) collided with obstruction & was injured. Ques: Does Standard negligence rule provide an incentive for victim to take e cient steps to avoid the accident after observing the injurer's negligence? 71 ffi fi fi fi Sequential Care Accidents - Injurer moves first Simple Negligence Contributory Negligence Strict Liability with Contributory Negligence If victim knows injurer Negligent victim liable If victim takes care, injurer violated due care standard regardless of injurer’s actions. strictly liable for the damages. (held liable), victim has no incentive to take Victim takes efficient Ensures that the victim takes precaution. precautions to avoid liability, care even when the injurer is at even in the face of observed fault. SN fails to create incentives negligence by injurer. for victim precaution when injurer is negligent. Adding CN defense to SN ensures victim has an incentive to take efficient care, even after observing the injurer’s negligence. Provides key advantage in promoting precautionary behaviour by victims. 72 Sequential Care Accidents - Victim moves first 2. Victim moves rst: (Davies v. Mann (1842)) Victim (donkey owner) tied his donkey next to a highway and left it unattended. Injurer drove his wagon down the highway and collided with the donkey, killing it. Both parties were found negligent: Victim for leaving the donkey unattended ; Injurer for driving at an excessive speed. Contributory Negligence: Victim would be barred from recovery since he was negligent. Injurer - no incentive to take care to avoid hitting the donkey, despite victim’s prior negligence. Simple Negligence: (better outcome): Injurer must meet the due standard to avoid liability, regardless of victim's negligence. Better incentive for injurer to take reasonable care. 73 fi  Sequential Care Accidents - Last Clear Chance Neither SN nor negligence with CN can always incentivise the 2nd mover in SCA to take care in presence of negligence by 1st. E cient rule depends on which party moves rst. Last Clear Chance rule introduced (Davies v. Mann) to address this de ciency. LCC: In SCA, the 2nd party (injurer/victim) has the ultimate duty to exercise precaution to avoid an accident, regardless of prior negligence by the 1st party. Cases where injurer moves rst: LCC similar to contributory negligence. If injurer negligent, victim still required to take due care to avoid liability under both rules. Cases where victim moves rst: LCC necessary addition to contributory negligence. Injurer required to take care despite victim’s prior negligence. LCC defeats injurer’s attempt to use CN as defense for his own negligence. 74 fi fi fi fi ffi Comparative Negligence Previous rules (e.g. SN, CN): all-or-nothing, assign full damages to injurer/victim. Comparative negligence divides damages based on relative fault of both parties. Addresses perceived unfairness in all-or-nothing rules, esp. where slightly negligent victims are barred from recovery. E.g. speeding driver hits a pedestrian walking on wrong side, comparative negligence adjusts liability based on relative fault (e.g., driver pays 75% of $50,000 medical bill). Pure comparative negligence: - If x ≥ x * , injurer avoids liability regardless of victim’s care choice - If x < x * & y ≥ y * , injurer (negligent) bears full liability; victim meets due care standard - If x < x * & y < y * (both negligent), both share liability proportionate to their fault. Injurer bears fraction s of damages, victim (1 - s) ; s ↑ with injurer's negligence & ↓ with victim's negligence. 75  Di ers from other negligence rules only in liability assignment when both parties negligent. - Simple negligence: Injurer bears liability - Negligence with contributory negligence: Victim bears liability - Comparative negligence: Both parties share liability based on relative fault. Comparative Negligence (General rule): simple negligence (s=1) & contributory negligence (s=0) - special cases. Comparative negligence also provides e cient incentives (like special cases). Drawbacks - Fairness diminishes in e cient eqbm: when both parties take due care, victim bears her own losses, similar to negligence rules. - Higher administrative costs: Courts must assess relative fault, di cult in cases of ambiguous responsibility (e.g., a drive-through co ee spill incident). 76 ff ffi ffi ff ffi  Comparative Negligence Comparative negligence may be superior under certain conditions: - Risk aversion of injurers & victims - Uncertainty about due standards of care - Di erences in costs of care for injurers - Sequential care accidents (White 1989) suggests that Contributory negligence provided stronger incentives for accident avoidance. Under comparative negligence, drivers took less than e cient care. 77 ffi ff Extensions of Basic Accident Model - Activity Levels Activity levels of parties: How intensively they engage in risky activities? E.g.: - Motorist: no. of miles to drive (activity level) + how fast to drive/inspect his car (care) - Manufacturer: no. of units to sell (activity level) + safety features (care) - Pilot: No. of ights operated/total ying hours (activity level) + conducting pre- ight checks, safety protocols, monitoring weather conditions (care) - Surgeon: no. of surgeries performed (activity level) + surgical protocols, sterilisation procedures, post-operative care guidelines (care) 78 fl fl fl Unilateral care model: a : injurer’s activity level B(a) : Gross bene ts (single-peaked curve maximized at a₀) In the absence of accident risk, a₀ : e cient level; where MB(a) = 0 79 fi ffi Impact of Activity on Accident Costs: Expected damages & costs of care - proportional to injurer’s activity level. e.g. If motorist drives twice as many miles, his costs double. Total expected accident costs: a[x + p(x)D(x)] Social OP: Max net bene ts: B(a) - a[x + p(x)D(x)] Two parts: - Choose optimal care x*: Minimises expected acc. costs (indep. of a): injurer - replicate optimal care choice each time - Choose optimal activity level a* (given optimal care): highest vertical dist. b/w B(a) & exp. acc. costs ; where MB = marginal accident costs Socially optimal a* < a₀ (gross bene ts max) since a₀ ignores accident costs 80 fi fi Choice under di. liability rules: No Liability Rule Strict Liability Rule Negligence Rule Injurer ignores victim’s Induces e cient care Injurer meets due standard of care damages; chooses (x*) & activity (a*) to avoid liability but does not excessive activity level a₀ since injurer internalize full accident costs. & zero care internalises all Injurer chooses a socially excessive damages. activity level (), though less excessive than under no liability. In UCM, Strict Liability is preferred to Negligence 81 ffi ff Extensions of Basic Accident Model - Activity Levels 82 Extensions of Basic Accident Model - Activity Levels 83 Applying the Economic Model of Tort Law Miceli Ch 3