ECON 1450 – Professor Berkowitz
Lectures on Chapter 2
• Tort Law
• Area of Common Law concerned with accidental
injuries
• Potential defendant engages in activity that puts the
plaintiff at risk
• Example – medical malpractice
• More examples – product liabilities, workplace
accidents, environmental accidents
Key issues
• Example of medical malpractice
• Obstetrician delivers babies
• There is always some risk involved in delivering babies
• We do not want the obstetrician to go out of business
or to practice “defensive” medicine
• We want the obstetrician to take all “cost-justified steps
to minimize the resulting cost”….
• Tort law designed to give potential defendants the
correct incentives
• Tort Law is a private remedy (versus public remedies
such as OSHA regulations, fines for speeding, etc)
Social Function of Tort Law
• Compensate victims
• Primary goal – deter unreasonably risky
behavior
Institutional Details
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Plaintiff has the burden of proof
1) Prove that plaintiff sustained damages AND
2) Prove that defendant was the cause
One 1) and 2) are established, then plaintiff
must prove the defendant was at fault
Prove Plaintiff was the cause
• Cause-in-fact and the “but for test”
– 2 or more simultaneous causes??
– Complementary plaintiffs
– Remote cause?
• Proximate Cause
Liability Rules
• If harm and causality are established, then
• Liability rule divides up damages between the
injurers and victim (plaintiff)
• No liability rule – “caveat emptor”
• Strict liability
• Negligence rule
Basic Model of Torts
• x = $ investment in precaution
• P(x) = probability of an accident: P’ < 0, P’’ > 0
• D(x) = severity of accident: D’ < 0, D’’ > 0
• Interpretation – there are increasing marginal
costs and declining marginal benefits
Expected Damages (ED)
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ED(x) = P(x)D(x)
ED’ = P’D + PD’ < 0 (interpret)
ED’’ = P’’D + 2P’D’ + PD’’ > 0 (interpret)
There is a diminishing MB of precaution
Let x = cost of precaution
Then, 1 = MC of precaution
Social optimum
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Choose x: Min D(x)P(x) - x
FOC: D’P + DP’ = 1 (interpret)
SOC: D’’P + 2D’P’ + DP’’ > 0 (interpret)
GRAPHIC REPRESENTATION (see figure 2.1 in
Micelli)
• The socially efficient outcome is x* where MB
= MC.
Positive Analysis
• No liability (caveat emptor) - inefficient
because the injurer sets x = 0
• Strict liability – efficient
• Partial liability – inefficient
• Negligence rule – “the due standard”
Strict Liability and Negligence
• Both rules are efficient (socially optimal), i.e.,
injurer always chooses x*
• Administrative costs – cost per case – strict
liability is cheaper
• Administrative costs – total cases – negligence
is cheaper
Errors in due standard
• Let xds denote the due standard
• Impact on negligence: suppose xds < x*, then
injurer is too risky;
• If x* < xds < x~ , then injurer is “too cautious”;
• If xds ≥ x~ then injurer is efficient, where xds
= P(x*)D(x*) + x*!!!
• Strict liability is always efficient
Courts Errors in calculating damages to
victim
• If court is too generous then it gives the
plaintiff αP(X)D(X), where α > 1
• If the court is too stingy then, α < 1
• Then, the injurer is too cautious when α > 1
and too risky when α < 1
• Negligence – as long as α is too far below 1,
then injurer chooses for α x**- the intution is
that at some point court awards are so cheap
that the injurer assumes full liability
Bilateral Care
• Victim should also be responsible for being
sufficiently cautious
• Then x = precaution by injurer, y = precaution
by victim, and
• P(x,y) = probability of an accident, when
• D(x,y) = severity of an accident
• There are diminishing marginal benefits of x
and y
Bilateral care, continued
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px < 0, pxx > 0, py < 0, pyy > 0
Dx < 0, Dxx > 0, Dy < 0, Dyy > 0
(ED)x < 0, (ED)xx > 0, (ED)y < 0, (ED)yy > 0
Social optimum is choose x + y, in order to
minimize x + y + ED(x,y) = x + y + p(x,y)D(x,y)
• FOC: Dx p + Dpx = 1
• FOC: Dy p + Dpy = 1
No liability versus strict liability
• No liability - Injurer chooses x = 0, and victim
chooses y: min y + p(0,y)D(0,y)… while y > 0 is
chosen it is inefficient because x = 0!
• Strict liability – victim chooses y = 0, and
injurer choose x: min x + p(x,0)D(x,0)….while
x>0 is chosen, it is inefficient because y = 0!
• Reality check – do victims really choose y=0??
Getting caveat emptor to be efficient
• Make the injurer cover the full amount of the
victim’s damages BUT do compensate the
victim for full damages!
• Injurer chooses x: min x + p(x,y)D(x,y)
• Victim chooses x: min y + p(x,y)D(x,y)
• Law does not work this way – in practice,
victim take what the injurer pays and so y = 0
Negligence in bilateral care model
• Let xds = x*, so that injurer has the following
pay-offs
• X + p(x,y)D(x,y) if x < x*
• X if x ≥ x*
• Does the victim choose y* (socially efficient
outcome)????
Victim does choose y*
• Nash equilibrium (expectations are rational) –
victim rationally anticipates that x=x* and
then chooses y: min y + p(x*,y)D(x*,y), so that
y=y*!
• Negligence is efficient because it allows the
injurer to avoid liability by paying x*, and
• Imposes actual liability on victim
Reality check on negligence
• With this rule, victim is NOT compensated for
damages
• As long as the due standard is met, nobody is
negligent
• In reality, due standard may be off, there are
differing costs of caution for different people,
and the injurer may not have the money to
pay x = x*
The Hand Rule and the Due Standard
• How is the due standard set??
• Judge Learned Hand – United States versus
Carroll Towing Co. (1947 – 2nd Circuit)
• P = probability that barge breaks away
• L = extent of injury
• B = burden of adequate precaution
• If B < PL => by the “hand rule” the barge
owner was negligent!
Reasonable person standard
• Injurers 1, 2 and 3 have differential costs of
care: c1 < c2 = 1 < c3
• Stories – Doctors at UPMC in Pittsburgh versus
Doctors in Haiti
• Efficient for differential care: x1* > x2* > x3*
• Because of administrative costs, law in general
does not differentiate – applies a uniform
standard based on the “reasonable person”
Problems with reasonable person
standard
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c1 < c2 = 1 < c3, and c2 = 1 is average
Set due standard at x* for the average person
Type c1 will under-invest
Type c3 will meet the due standard if c3 not
too much higher than 1, will meet the due
standard and be too cautious…
• When c3 is sufficiently greater than 1,
however, this person is socially efficient
(behaves as if strictly liable)
Contributory negligence
• Bilateral model – NOW victim also must the
due standard if he/she wants to recover for
damages
• Butterfield versus Forrester (1809)
• Suppose the due standard for injurer and
victim is set correctly – then, this rule is
efficient
Contributory negligence
• Simple negligence rule – “Negligence with
contributory negligence”
• Strict liability – “Strict liability with
contributory negligence”
Negligence with contributory
negligence
• Law established xdue and ydue – and – suppose
these are set at the “efficient” levels
• If x ≥ x*, injurer is off the hook (victim has to
cover costs), if x < x* and y < y*, injurer is still
off the hook and if x < x* and y ≥ y*, the
injurer compensates the victim
• GET EFFICENT OUTCOME – injurer and victim
have rational expectations about each other
(Nash equilibrium argument)
Strict Liability with Contributory
Negligence
• In this case only victim’s standard of care
matters
• If y ≥ y*, the injurer must pay the victim, and
• If y < y*, the injurer is off the hook
• Get efficient outcome (Nash equilibrium
argument)
Comparative Negligence
• Goes beyond “all or nothing” rules
• This rule divides damages based on relative
fault of victim and injurer
• Curran (1992) – 44 as of 1992 have some form
of this rule
• Exercise 2.2 – shows how this rule can be
efficient in a bilateral care setup
Negligence
• Pure comparative negligence combines
negligence with contributory negligence and
simple negligence
• Combination – generalizes case of x < x* and y
< y*
• Prove social efficiency when due standard is
efficient
Activity Levels
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Number of activities = a
B(a) = benefits of activities: B’ > 0, B’’ < 0
example – numbers of railroads built
Choose a, x: maximize B(a) – a[x + P(x)D(x)]
x* minimizes costs
Properties of a* (optimal activity level)
Activity Levels and Rules
• No liability – inefficient
• Strict liability – efficient
• Negligence – with an efficient due standard
(x*) is inefficient
Punitive damages
• Relevant when court determines that injurers
activities are intentional and/or reckless
• Deter potential injurers
• Unilateral care model
• α = 1/3 (for example) = probability that a
guilty injurer will be found liable (for example,
the case is complex, the courts are understaffed, etc)
Punitive damages, cont’d
• Choose x: min x + p(x)αD(x) = min x +
p(x)(1/3)D(x)
• Injurer therefore choose x~(α=1/3) < x*
• R = punitive damages awarded by the court in
the event of a successful conviction
• Then, p(x)α{D(x) + R} = p(x)D(x):
• R = ((1- α)/α) D(x) = 2D(X) when α = 1/3
• See exercise 2.3
Judgment proof problems
• Injurer found liable but lacks assets to pay
damages
• Incentive issue – an injurer who anticipates he
will be judgment proof in the future may take
too little precaution today
• Strict liability – injurer anticipate going
bankrupt will under-invest in precaution
Judgment proof, cont’d
• Negligence can be efficient
• Suppose xds = x*, and α <= 1 is the probability
of being in business in the near future
• Choose x: Min x + αp(x)D(x) if x < x* and
• Choose x if x >= x*
• Then, as long as α is not too small, due
standard is met!