Econ 522
Economics of Law
Dan Quint
Fall 2012
Lecture 19
Outline of the next few weeks
 Remaining lectures
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Today: wrap up tort law
Wednesday: the legal system in general
Next week (Dec 3 and 5): criminal law
Mon Dec 10: behavioral economics and the law
Wed Dec 12: return to efficiency, wrap-up
 Remaining logistics
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HW4 will be up online today, due Thursday Dec 6
Midterm 2 will (hopefully) be returned Wednesday
Final exam Wed Dec 19, 12:25 p.m., Soc Sci 6210
1
Jumping back into tort law
 Coase Theorem relied on voluntary negotiations to allocate
goods, and rights, efficiently
 Certain interactions, ex-ante negotiations not feasible
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I can’t negotiate with everyone in Madison over how carefully I
should drive
Best we can do: design rules that make “good” behavior in my own
private interest
 Several ways we could discourage adverse behavior
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“Punish the behavior” – criminal law, speed limits, safety regulation
“Punish the outcome” – strict liability rule
“Punish the combination of behavior and outcome” – negligence rule
2
Jumping back into tort law
“I hear in some places, you need one form of ID to buy a
gun, but two to pay for it by check. It’s interesting who
has what incentives to care about what mistakes.”
- XKCD
3
Jumping back into tort law
 We’ve focused on a few particular incentives:
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Injurer precaution
Victim precaution
Injurer activity level
Victim activity level
 …and considered what would happen under a rule of…
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No liability
Strict liability
Various versions of a negligence rule
Both in interactions between private individuals…
…and between businesses and individuals
4
Jumping back into tort law
 Also examined how legal standard for negligence is set
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Hand Rule: efficient precautions are required
Other ways: safety standards, industry norms
 …and the effect of errors in implementing each rule
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Strict liability rule: random errors in calculating damages
have no effect, systematic errors do
Negligence rule: small errors in damages have no effect;
errors in standard for negligence have strong effect;
uncertainty in legal standard leads to overprecaution
 …and the effects of other “complications”
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Irrationality; judgment-proofness; regulation; insurance;
costly litigation
5
Experiment
6
My favorite problem
from an old exam
7
More twists
on liability
8
Vicarious Liability
 Vicarious liability is when one person is held liable
for harm caused by another
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Parents may be liable for harm caused by their child
Employer may be liable for harm caused by employee
 Respondeat superior –
“let the master answer”
 Employer is liable for torts
of employee if employee
was acting within the
scope of his employment
9
Vicarious Liability
 Gives employers incentive to...
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be more careful who they hire
be more careful what they assign employees to do
supervise employees more carefully
 Employers may be better able to make these decisions
than employees…
 …and employees may be judgment-proof
10
Vicarious Liability
 Vicarious liability can be implemented through…
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Strict liability rule: employer liable for any harm caused by
employee (as long as employee was acting within scope of
employment)
Negligence rule: employer is only liable if he was negligent in
supervising employee
 Which is better? It depends.
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If proving negligent supervision is too hard, strict vicarious liability
might work better
But an example favoring negligent vicarious liability…
11
Joint and Several Liability
 Suppose you were harmed by accident caused by two
injurers
 Joint liability: you can sue them both together
 Several liability: you can sue each one separately
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Several liability with contribution: each is only liable for his share
of damage
 Joint and several liability: you can sue either one for the
full amount of the harm
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Joint and several liability with contribution: the one you sued
could then sue his friend to get back half his money
12
Joint and Several Liability
 Joint and several liability holds under common law
when…
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Defendants acted together to cause the harm, or…
Harm was indivisible (impossible to tell who was at fault)
 Good for the victim, because…
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No need to prove exactly who caused harm
Greater chance of collecting full level of
damages

Instead of suing person most responsible,
could sue person most likely to be able to pay
13
Punitive
damages
14
Inconsistency of damages
 Damage awards vary greatly across countries, even across
individual cases
 We saw last week:
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As long as damages are correct on average, random inconsistency
doesn’t affect incentives (under either strict liability or negligence)
 But, if appropriate level of damages isn’t well-established,
more incentive to spend more fighting
15
One problem with inconsistent damages:
more incentive to fight hard
 Example: each side can hire cheap lawyer or expensive
lawyer
 Cheap lawyer costs $10, expensive lawyer costs $45
 If two lawyers are equally good, expected judgment is $100
 If one is better, expected judgment is doubled or halved
Plaintiff
Defendant
Cheap Lawyer
Expensive Lawyer
Cheap
Expensive
90, -110
40, -95
155, -210
55, -145
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Punitive damages
 What we’ve discussed so far: compensatory damages
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Meant to “make victim whole”/compensate for actual damage done
 In addition, courts sometimes award punitive damages
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Additional damages meant to punish injurer
Create stronger incentive to avoid initial harm
 Punitive damages generally not awarded for innocent
mistakes, but may be used when injurer’s behavior was
“malicious, oppressive, gross, willful and wanton, or
fraudulent”
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Punitive damages
 Calculation of punitive damages even less well-defined
than compensatory damages
 Level of punitive damages supposed to bear “reasonable
relationship” to level of compensatory damages
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Not clear exactly what this means
U.S. Supreme Court: punitive damages more than ten times
compensatory damages will attract “close scrutiny,” but not explicitly
ruled out
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Example of punitive damages: Liebeck v
McDonalds (1994) (“the coffee cup case”)
 Stella Liebeck was badly burned when she spilled a cup of
McDonalds coffee in her lap
 Awarded $160,000 in compensatory damages, plus $2.9
million in punitive damages
 Case became “poster child” for excessive damages, but…
19
Liebeck v McDonalds (1994)
 Stella Liebeck dumped coffee in her lap while adding
cream/sugar
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Third degree burns, 8 days in hospital, skin grafts, 2 years treatment
Initially sued for $20,000, mostly for medical costs
McDonalds offered to settle for $800
 McDonalds serves coffee at 180-190 degrees
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At 180 degrees, coffee can cause a third-degree burn requiring skin
grafts in 12-15 seconds
Lower temperature would increase length of exposure necessary
McDonalds had received 700 prior complaints of burns, and had
settled with some of the victims
Quality control manager testified that 700 complaints, given how
many cups of coffee McDonalds serves, was not sufficient for
McDonalds to reexamine practices
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Liebeck v McDonalds (1994)
 Rule in place was comparative negligence
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Jury found both parties negligent, McDonalds 80% responsible
Calculated compensatory damages of $200,000
times 80% gives $160,000
Added $2.9 million in punitive damages
Judge reduced punitive damages to 3X compensatory, making total
damages $640,000
During appeal, parties settled out of court for some smaller amount
 Jury seemed to be using punitive damages to punish
McDonalds for being arrogant and uncaring
21
What is the economic purpose of punitive
damages?
 We’ve said all along: with perfect compensation, incentives
for injurer are set correctly. So why punitive damages?
 Example…
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Suppose manufacturer can eliminate 10 accidents a year, each
causing $1,000 in damages, for $9,000
Clearly efficient
If every accident victim would sue and win, company has incentive to
take this precaution
But if some won’t, then not enough incentive
Suppose only half the victims will bring successful lawsuits
Compensatory damages would be $5,000; company is better off
paying that then taking efficient precaution
One way to fix this: award higher damages in the cases that are
brought
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This suggests…
 Punitive damages should be related to compensatory
damages, but higher the more likely injurer is to “get away
with it”
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If 50% of accidents will lead to successful lawsuits, total damages
should be 2 X harm
Which requires punitive damages = compensatory damages
If 10% of accidents lead to awards, damages should be 10 X harm
So punitive damages should be 9 X compensatory damages
 Seems most appropriate when injurer’s actions were
deliberately fraudulent, since may have been based on costbenefit analysis of chance of being caught
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Some empirical observations
about tort system in the U.S.
(might not get to)
Skip
24
U.S. tort system
 In 1990s, tort cases passed contract cases as most
common form of lawsuit
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Most handled at state level: in 1994, 41,000 tort cases resolved in
federal courts, 378,000 in state courts in largest 75 counties
Most involve a single plaintiff (many contract cases involve multiple
plaintiffs)
 Among tort cases in 75 largest U.S. counties…
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60% were auto accidents
17% were “premises liability” (slip-and-fall in restaurants,
businesses, government offices, etc.)
5% were medical malpractice
3% were product liability
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U.S. tort system
 Punitive damages historically very rare
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1965-1990, punitive damages in product liability cases were
awarded 353 times
Average damage award was $625,000, reduced to $135,000 on
appeal
Average punitive damages only slightly higher than compensatory
 In many states, punitive damages limited, or require higher
standard of evidence
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Civil suits generally require “preponderance of evidence”
In many states, punitive damages require “clear and convincing”
evidence
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U.S. tort system
 Medical malpractice
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New York study in 1980s: 1% of hospital admissions involved
serious injury due to negligent care
Some estimates: 5% of total health care costs are “defensive
medicine” – procedures undertaken purely to prevent lawsuits
Some states have considered caps on damages for medical
malpractice
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U.S. tort system
 Product liability
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Recent survey of CEOs: “liability concerns caused 47% of those
surveyed to drop one or more product lines, 25% to stop some
research and development, and 39% to cancel plans for a new
product.”
 Liability standard for product-related accidents is “strict
products liability”
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Manufacturer is liable if product determined to be defective
Defect in design
Defect in manufacture
Defect in warning
28
Vaccines
 Most vaccines are weakened version of disease itself
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Make you much less likely to acquire the disease
But often come with very small chance of contracting disease
directly from vaccine
Salk polio vaccine wiped out polio, but caused 1 in 4,000,000
people vaccinated to contract polio
 1974 case established maker had to warn about risk
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Since then, some people were awarded damages after their
children developed polio from vaccine
If liability can’t be avoided, built into cost of the drug
And discourages companies from developing vaccines
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Mass torts
 Since health risks of asbestos understood, over 600,000
people have brought lawsuits against 6,000 defendants
 DES (drug administered to pregnant women in 1950s)
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Impossible to establish which firm produced dose given to a
particular woman
California Supreme Court introduced “market share liability”
 Class action lawsuit
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Small, dispersed harms – no plaintiff might find it worthwhile to sue
Class action suits allow large lawsuits with lots of plaintiffs
Give more incentive for precaution against diffuse harms
But…
30
Cooter and Ulen’s overall assessment of
U.S. tort system
 Critics claim juries routinely hand out excessive awards
and tort system is out of control…
 …but actually it functions reasonably well
 Outside of occasional, well-publicized outliers, damage
awards are generally reasonable…
 …and liability has led to decreases in accidents in many
industries
31
To wrap up tort law, a funny story from
Friedman…
“A tort plaintiff succeeded in collecting a large damage judgment.
The defendant’s attorney, confident that the claimed injury was
bogus, went over to the plaintiff after the trial
and warned him that if he was ever seen out of his wheelchair
he would be back in court on a charge of fraud.
The plaintiff replied that to save the lawyer the cost of having
him followed, he would be happy to describe his travel plans.
He reached into his pocket and drew out an airline ticket –
to Lourdes, the site of a Catholic shrine famous for miracles.”
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