Economics of
Tort Law
What is a tort?
Contract law: injury from a broken promise
Tort law: injury without any promises
“If someone shoots you, you call a cop. If he
runs his car into yours, you call a lawyer.”
 Intentional tort
(≈ crime)
 Unintentional tort (accidents)
Focus on efficiency: structure the law to provide
the correct incentives to avoid/prevent harm
Example 1: Joe Potatoes
Joe Potatoes has been driven to distraction by the
escapades of his wife, Joan Potatoes. At the end
of a hard night’s work at the loading dock, Joe is
approached by Jim Bloggs. Suspecting that Jim
has been romancing Joan, Joe insults and strikes
him, breaking his nose. Bloggs subsequently
sues for the injury to his reputation and his nose.
Example 2: Pheasant Hunting
Three hunters go into the woods after pheasants.
They are spread out in a straggling line about 25
yards apart, walking in the same direction. The
hunter in the center flushes a bird that flies up,
its wings pounding. The hunter to his left and
right turn toward the bird in the middle and fire.
The bird escapes, but the hunter in the middle is
blinded by birdshot. One of the two hunters
certainly caused the harm, but there is no way of
determining which one of them it was.
The
victim sues both of them.
Example 3: Fuel Additives
A manufacturer produces auto fuel additives that demand
careful control over quality. If quality control is maintained
at a high level, the chemical mixture in the product is
correct, and it never causes damage to auto engines. If,
however, quality control is relaxed and allowed to fall to a
low level, some batches of the chemical mixture will be
flawed. A few of the cars using the flawed batch will be
harmed; specifically, the engine will throw a rod and tear
itself to pieces. After the rod is thrown, as alert mechanic
can detect the cause of the harm. The manufacturer
determines that a high level of control costs more than the
harm to some auto engines caused by a low level of quality
control, so the manufacturer adopts a low level of quality
control. The owner of the damaged car sues the
manufacturer and asks for punitive damages.
Classroom Experiment
 Victor Matheson (2005), “Rationality, Tort Reform and
Contingent Valuation: A Classroom Experiment in Starting
Point Bias.” College of the Holy Cross Working Paper
Focal Point Experiment
Reference Point
$10,000
$1,000,000
Smallest Damages
$100,000
$500,000
Largest Damages
$1,000,000
$2,000,000
Median Damages
$500,000
$650,000
$1m or less
5 out of 6
4 out of 6
Traditional Theory of Torts
Harm
Can you sue for exposure to harm?
 Perfect compensation?
 Tangible vs intangible losses
Causation
Does smoking cigarettes cause cancer?
 “cause-in-fact”:but for A, would B have occurred?
If NO, then A is the cause-in-fact of B
 Proximate cause
Breach of duty (fault)
 Strict liability: only Harm and Causation matter
 Negligence: requires Harm, Causation, and Fault
How do you determine fault?
 Binary fault
 Continuous fault
 not at fault if x ≥
 at fault if x < ~
x
~
x
Not at fault
Negligent
Precaution (x)
0
~
x
Legal standard: reasonable person
A Trolley Folly
“A tree fell on a moving trolley, injuring passengers. One
of them sued. He succeeded in demonstrating that in order
for the trolley 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 trolley would not have been under
the tree when it fell, so, the plaintiff argued, the driver’s
negligence caused the injury.”
The court held that the driver’s negligence “had not
caused the accident in the legally relevant sense.”
A Model of Optimal Precaution
 Social Objective: minimize social costs of accidents
 Precaution costs
 Accident losses
 Administrative costs
 Assumptions




Rationality
Litigation is costless
No insurance available
No safety regulation
A Model of Optimal Precaution
 Define:




x = level of precaution by injurer
p(x) = probability of accident [p’(x) < 0]
A = victim’s accident losses
w = cost per unit of precaution
Social Costs = wx + p(x)A
What level of x will minimize Social Costs?
A Model of Optimal Precaution
$
Social Costs = wx + p(x)A
SC
wx
p(x)A
x*
x* occurs where:
Precaution (x)
w = -p’(x)A
MC of precaution = MB of precaution
Examples of Accidents and Precaution
Accident
Injurer’s precaution
Victim’s precaution
Faulty wiring causes
house fire
Manufacture wiring
more carefully
Fireproof the house
Moving car hits parked
car
Drive more safely
Park car in safer location
Car hits pedestrian
Drive more safety
Walk more safely
Software fails
Better design of software Back up data at risk
Exploding pop bottle
Improve quality control
Handle bottles carefully
Medicine causes side
effects
Improve warning label
Study warning on
medicine
Incentives for Precaution
Tort liability gets injurer to internalize the
harm they cause victims
3 Liability Rules
 No Liability
 Strict Liability
 Negligence rule
No Liability
Victim’s Incentives
 Victim bears full cost of accident
 Victim’s cost = wvxv + p(xv)A
 Choose xv*
Injurer’s Incentives
 Injurer faces no liability
 Choose xi = 0
 Injurer’s cost = wixi
Strict Liability
Victim’s Incentives
 Victim receives damages of D
 Victim’s cost = wvxv + p(xv)[A-D]
 Victim’s cost = wvxv (if D = A)
 Choose xv = 0
Perfect compensation
Injurer’s Incentives
 Injurer’s cost = wixi + p(xi)D
 Choose xi*
No Liability vs Strict Liability
Legal Rule
No liability
Strict liability
Victim’s Precaution
Efficient
Injurer’s Precaution
Zero
Zero
Efficient
 Unilateral precaution situations:
 When only victim can take precaution, NL is preferable
 When only injurer can take precaution, SL is preferable

Analogous to contract law where we should
Bilateral
precaution
situations?
allocate
risk to the low-cost
avoider.
Simple Negligence Rule
Injurer’s Incentives
 if x < ~
x then D = A
Injurer’s cost = wixi + p(xi)D
 if x ≥
~
x
then D = 0
Injurer’s cost = wixi
Simple Negligence Rule
$
wx + p(x)A
wx
~
x
= x*
Injurer will choose xi*
What will victim do?
Precaution (x)
Contributory Negligence
Negligent injurer can escape liability if
victim was also negligent
I’m talking on my cell phone while driving,
but drunk pedestrian stumbles into road
 Victim has incentive to choose xv*
 Injurer has incentive to choose xi*
Since injurer expects victim to take efficient precaution,
injurer will minimize costs by being careful
Comparative Negligence
If both parties are negligent, they share
the responsibility
 Injurer has incentive to choose xi*
 Victim has incentive to choose xv*
Liability Rule Summary
Legal Rule
No liability
Strict liability
“Any” negligence rule with
efficient standards of care
Victim’s
Precaution
Efficient
Injurer’s
Precaution
Zero
Zero
Efficient
Efficient
Efficient
Warning: Activity levels also affect the likelihood of an accident
Who bears “residual risk”?
Efficient Precaution and Activity
Legal Rule
No Liability
Victim
Injurer
Precaution Precaution
Victim
Activity
Injurer
Activity
Efficient
Zero
Efficient
Too High
Zero
Efficient
Too High
Efficient
Simple
Negligence
Efficient
Efficient
Efficient
Too High
Contributory
Negligence
Efficient
Efficient
Efficient
Too High
Comparative
Negligence
Efficient
Efficient
Efficient
Too High
Strict Liability
with CN
Efficient
Efficient
Too High
Efficient
Strict Liability
Setting the Standard: The Hand Rule
 United States v Carroll Towing Company (1947)
Since
there
are occasions
when every
will is
break
from her

Hand
Rule:
if w < -p’A
thenvessel
injurer
negligent
moorings, and since, if she does, she becomes a menace to
those about her; the owner’s duty, as in other similar situations,
 Have
all cost-justified
precautions
been
to provide
against
resulting injuries
is a function
of taken?
three
variables: (1) The probability that she will break away; (2) the
gravity of the resulting injury, if she does; (3) the burden of
 Case-by-case basis
adequate precautions. Possibly it serves to bring this notion into
Regulations
relief to 
state
it in algebraic terms: if the probability be called P;
the injury,
L; and customs
the burden, B; liability depends upon whether
 Social
B is less than L multiplied by P: i.e., whether B < PL.
Judge Learned Hand
Errors in Damage Awards
 Random mistakes
 Systematic mistakes
Strict Liability
 Random mistakes: no effect on precaution
 Systematic mistakes: xi varies directly with error
Negligence Rule
 Modest damage errors will not affect xi
 xi varies directly with errors in setting the legal
standard
Administrative Costs
Social Cost = wx + p(x)A + C
 No Liability: saves on C but erodes incentive for
precaution
 Strict Liability: requires harm and cause
 Leads to more cases, but easier cases
 Negligence: requires harm, cause, and fault
 Leads to fewer cases, but costlier cases
Exploding Pop Bottle
Behavior
of Firm
Firm’s
Cost of
Production
per unit
Probability
Loss if
of Accident
Accident
to Consumer
Expected
Accident
Loss
Full Cost
per unit
Use Bottle
40 cents
1/100,000
$10,000
10 cents
50 cents
Use Can
43 cents
1/200,000
$4,000
2 cents
45 cents
When consumers have perfect information, the
choice of liability rule is irrelevant; every rule
generates efficient precaution and output
Strict Liability is a substitute for perfect consumer information