Econ 522
Economics of Law
Dan Quint
Fall 2009
Lecture 15
Logistics
 HW2 due Tuesday (11 a.m. sharp)
 Second midterm next Thursday (Nov 5)
1
On the topic of illegal contracts…
2
Let’s recap our
story so far…
3
Our story so far
 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
4
Our story so far
 Coase gives us one way to do that



As long as property rights are clearly defined and tradeable, 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
5
Our story so far
 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
6
Our story so far
 Property law works well when transaction costs are low
enough to get voluntary trade
 Contract law works well when transaction costs are low
enough that we can agree to a contract, but high enough
that we may not want to renegotiate the contract later
 What about when transaction costs are too high to agree
to anything in advance?
 This is tort law
7
Tort law
8
Tort law
 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.”
9
Tort law
 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”
10
Tort law
 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”
11
Cast of characters
 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; defendant is the injurer
12
“Classic” legal theory of torts
 Harm
 Causation
 Breach of Duty
13
Element 1: Harm
 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
14
Element 1: Harm
Money
Health
 Perfect compensation


restores victim to original level of well-being
generally done through money damages
15
Perfect Compensation
Tangible harms
• Medical costs
• Lost income
• Damaged property
Intangible harms
• Emotional harm
• Pain and suffering
• Loss of companionship
 Historically, courts less willing to compensate for intangible or hardto-measure losses
 Over time, American courts have started compensating for more
intangible harms

Pro: closer liability is to actual harm done, better incentives for avoidance of
these harms
 Con: disparity in award sizes, unpredictability
16
“Classic” legal theory of torts
 Harm
 Causation
 Breach of Duty
17
Element 2: Causation
 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?”
18
Element 2: Causation
 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
19
Element 2: Causation
“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”
20
“Classic” legal theory of torts
 Harm
 Causation
 Breach of Duty
21
Element 3: Breach of Duty
(Sometimes required, sometimes not)
Strict Liability
• Harm
• Causation
Negligence
• Harm
• Causation
• Breach of duty (fault)
 When someone breaches a duty he owes to the
defendant, and this leads to the harm, the injurer is
at fault, or negligent

Under a negligence rule, even if I caused you harm, I’m not liable if I
had taken the required standard of care and the accident
happened anyway
22
Hence the language in the trolly example
“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.”
23
So under a negligence rule…
 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?
24
How is the standard of care determined?
 Some settings: government imposes safety regulations
that set 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)
25
Strict liability versus negligence
 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
26
“Classic” legal theory of torts
 Harm
 Causation
 Breach of Duty
27
The law as a set
of incentives
28
Something to remember
distribution
but not
efficiency
efficiency
29
The law as incentives – HW2 Q3
(from old midterm)
A physician comes upon an auto accident, stops, and treats an
unconscious and badly bleeding victim. A week later the victim
receives a bill for services rendered. Must he pay it?
Under current U.S. law the answer is yes.
Consider the following alternatives:
i. The victim need not pay anything
ii. The victim must pay only the value of whatever materials were used
up in treating him (bandages, etc.)
iii. The victim must pay the going market rate for comparable medical
services
iv. The victim must pay whatever the doctor demands
Which of these do you expect to lead to the most efficient
outcomes? Why?
30
If we think about payoffs after the fact
(after accident, after treatment)…
 Suppose value of treatment is $100,000, cost of materials $50,
value of doctor’s time $450, market rate $1,000
Pay
Nothing
Cost of
Materials
Market
Rate
Whatever
Doc Asks
Patient’s
Payoff
$100,000
$99,950
$99,000
-$900,000
Doctor’s
Payoff
-500
-450
500
999,500
99,500
99,500
99,500
99,500
Combined
Payoffs
 After the fact, all remedies are equally efficient
 So this can’t be the right way to think about the problem!
31
So what is the right way to think about the
problem?
 Need to think about incentive each rule creates, therefore
the behavior it will lead to

Patient pays nothing

Patient pays for materials

Patient pays market rate

Patient pays whatever doctor asks
32