Econ 522 Economics of Law

Econ 522Economics of Law Dan Quint Spring 2010 Lecture 15

Logistics • HW2 due Wednesday (2:30 p.m. sharp) • Second midterm next Wednesday (March 24)

In-class experiment from last Wednesday… • The game: • Players A and B each start with $10 • Player A gives x to player B, which gets tripled • Player B gives y back to player A, keeps 10 + 3x – y • The treatments: • Totally anonymous: done randomly, on paper, with SID (no names) • In pairs, face to face, but with strategies written down • In pairs, out loud, in front of whole class

The results • In both “face-to-face” and “public” versions, trust was not a problem • In both cases, every player A sent $10, so efficiency was achieved (maximum possible combined payoffs) • In both cases, player B sent back $20 on average • So player A trusted, and was rewarded • In the anonymous version, trust was a problem, but not a huge problem • Average A transferred $6.68, got back $8.35 • So two-thirds of potential gains were realized • Of those Player A’s who sent anything, 27% got back nothing, and 34% got back less than they gave

The raw data (anonymous version)

Summary of results Average A Transfer Average B Transfer Average A Payoff Average B Payoff Average Combined Anonymous 6.7 8.4 11.7 21.7 33.4 Face to Face 10.0 20.0 20.0 20.0 40.0 Out Loud 10.0 20.0 20.0 20.0 40.0

More information on the anonymous treatment Player A gave Observa-tions % that got nothing back % that got less than they gave Average Payoff “Average return” 0 – 2 7 100% 0% 9.7 0% 3 – 7 15 33% 33% 11.3 127% 8 – 10 25 20% 32% 12.4 125%

On the topic of illegal contracts…

Let’s recap ourstory so far…

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

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

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

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

Tort law

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.”

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”

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”

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 (person who was harmed) • Defendant is the injurer (person who caused the harm)

“Classic” legal theory of torts • Harm • Causation • Breach of Duty

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

Element 1: Harm Money Health • Perfect compensation • restores victim to original level of well-being • generally done through money damages

Perfect Compensation Tangible harms Intangible harms • Medical costs • Lost income • Damaged property • Emotional harm • Pain and suffering • Loss of companionship • In theory, perfect compensation should cover all losses • Historically, courts have been less willing to compensate for intangible or hard-to-measure losses • Over time, U.S. courts have started compensating for more intangible harms • Pro: the closer liability is to actual harm done, the better the incentive to avoid these harms • Con: disparity in award sizes, unpredictability

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?”

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

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”

(Sometimes required, sometimes not) Element 3: Breach of Duty Strict Liability Negligence • Harm • Causation • 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 • Injurers owe victims the duty of due care • Negligence rule: I’m only liable if I failed to take the required standard of care – not if I was careful and the accident happened anyway

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.”

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?

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)

Strict liability versus negligence • Strict liability rule: plaintiff must prove harmand 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

Precaution

Lots of things both victims and injurers can do to reduce number (or harm) of accidents Accident Injurer’s Precaution Victim’s Precaution faulty electrical wiring causes house fire manufacture wiring more carefully fireproof house moving car hits parked car drive more safely park car in safer space car hits pedestrian drive more safely walk more safely software fails better design of software back up data at risk exploding coke bottle improve quality control by bottler handle bottles carefully medicine causes side effects improve warning on medicine study warning on medicine Cooter and Ulen, p. 338

We will call all these things precaution • Precaution: anything either injurer or victim could do to reduce likelihood of an accident (or damage done) • The next two questions should be obvious… • How much precaution do we want? • What is efficient level of precaution? • How do we design the law to get it?

Econ 522 Economics of Law