Econ 522Economics of Law
Dan Quint
Fall 2009
Lecture 19
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Midterm 2Question 3a
“Explain why expectation damages lead to efficient breach”
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In this class, we generally ask two distinct questions
What do we expectpeople to actually do?
What actionswould be efficient?
vs.
Promisor’scost of
performingvs.
Promisee’s benefit from performance
Promisor’scost of
performingvs.
Promisor’s liability from
breach
Example: promisor’s decision to perform on contract
Expectation damages: set promisor’s liability = promisee’s benefit Or, make private benefit from performance = social benefit Promisor “internalizes the externality” caused by breach This way, promisor’s action matches the efficient one
SocialCost
SocialBenefit
vs.PrivateCost
PrivateBenefit
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In this class, we generally ask two distinct questions
What do we expectpeople to actually do?
What actionswould be efficient?
vs.
Cost of injurer
precautionvs.
Reduction in expected
harm
Cost of injurer
precautionvs.
Reduction in expected liability
Another example: injurer precaution under strict liability
Strict liability + perfect compensation: injurer’s liability = actual harm Again, private benefit from precaution = social benefit Injurer internalizes the externality caused by accidents he causes And so injurer’s level of precaution matches the efficient one
SocialCost
SocialBenefit
vs.PrivateCost
PrivateBenefit
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Back to work:more twists on liability
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Vicarious liability is when one person is held liable for harm caused by another 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 unintentional torts of employee if employee was acting within the scope of his employment
Vicarious Liability
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Gives employers incentive to... 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
Vicarious Liability
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Vicarious liability can be implemented through… 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. If proving negligent supervision is too hard, strict vicarious liability
might work better But an example favoring negligent vicarious liability…
Vicarious Liability
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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 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 Joint and several liability with contribution: the one you sued could
then sue his friend to get back half his money
Joint and Several Liability
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Joint and several liability holds under common law when… Defendants acted together to cause the harm, or… Harm was indivisible (impossible to tell who was at fault)
Good for the victim, because… 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
Joint and Several Liability
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Negligence with a defense of contributory negligence was dominant liability rule in common law countries Negligent injurer is liable, unless victim was also negligent Example: a car going 60 mph hits a car going 35 in a 30-mph zone Since victim was also negligent, injurer is not liable
Last 40 years, most U.S. states have adopted a comparative negligence rule Usually through legislation, sometimes through judicial decision Appealing from fairness point of view But any negligence rule leads to efficient precaution So how do we explain the move?
Comparative Negligence
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Evidentiary uncertainty Given a legal standard for negligence, xn… …and an actual level of precaution taken, x… still uncertainty in whether the court will find negligence
Evidentiary uncertainty, like random errors in setting xn, leads to over-precaution…
…but comparative negligence partly mitigates this
Comparative Negligence and Evidentiary Uncertainty
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Comparative negligence and evidentiary uncertainty
x
$
p(x) A
wx
wx + p(x) A
x*
Comparative negligence mitigates effect of evidentiary uncertainty
An
y n
egli
gen
ce r
ule
Sim
ple
neg
ligen
ce,
evid
entia
ry u
ncer
tain
ty
Com
par
ativ
e n
eglig
ence
, ev
iden
tiary
unc
erta
inty
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PerfectCompensation
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Perfect compensatory damages (D = A) Returns victim to original level of well-being (Works like insurance) And sets correct incentive for injurers
But in some cases, hard to determine level Might be no price at which you’d be willing to give up a leg Certainly no price at which a parent would be indifferent toward
losing a child
Perfect compensation
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Recommended jury instructions, Massachusetts: “Recovery for wrongful death represents damages to the survivors for
the loss of value of decedent’s life. There is no special formula under the law to assess the plaintiff’s damages…
It is your obligation to assess what is fair, adequate, and just. You must use your wisdom and judgment and your sense of basic
justice to translate into dollars and cents the amount which will fully, fairly, and reasonably compensate the next of kin for the death of the decedent.
You must be guided by your common sense and your conscience on the evidence of the case…”
And from California: “…You should award reasonable compensation for the loss of love,
companionship, comfort, affection, society, solace or moral support.”
Perfect compensation
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Most people would rather be horribly injured than killed
Which means killing someone does more damage than injuring someone
But compensatory damages tend to be lower for a fatal accident than an accident which crippled someone When someone is badly injured, may require huge amount of
money to compensate them In wrongful-death case, damages compensate victim’s loved
ones, but no attempt to compensate victim So these damages tend to be smaller
One other odd feature of compensatory damages…
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What’s a lifeworth?
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Assessing damages in a wrongful death lawsuit requires some notion of what a life is worth
Safety regulators also need some notion of what a life is worth Kip Viscusi, The Value of Risks to Life and Health
Regulators need to decide “where to draw the line”
What’s a life worth?
$72,000,000,000Proposed OSHA formaldehyde standard
$ 104,200,000EPA asbestos regulations
$ 89,300,000OSHA asbestos regulations
$ 1,300,000Car side door protection standards
$ 200,000Airplane cabin fire protection
Estimated cost per life savedRegulation
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If w is starting wealth, D is death, p is probability, there might be some amount of money M such that
p u(D) + (1 – p) u(w + M) = u(w)
When p 1, this breaks down not because you can’t equate death with compensation, but because the second term vanishes
So how do we find M? Ask a bunch of people how much money they would need to take a
1/1000 chance of death? Can’t do a lab experiment where you actually expose people to a risk
of death! Clever trick: impute how much compensation people require from the
real-life choices they make
Kip Viscusi, The Value of Risks to Life and Health
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Lots of day-to-day choices increase or decrease our risk of death Choose between a sports car with fiberglass body and a Volvo Take a job washing skyscraper windows, or office job that pays less Buy smoke detectors and fire extinguishers, or don’t
“Hand Rule Damages” Hand Rule: precaution is cost-justified if
cost of precaution < reduction in accidents X cost of accident Suppose side-curtain airbags reduce risk of fatal accident by 1/1000 If someone pays $1,000 extra for a car with side-curtain airbags, it must
mean that
$1,000 < 1/1000 * value of their life or, they value their life more than $1,000,000
Kip Viscusi, The Value of Risks to Life and Health
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Viscusi surveys lots of existing studies which impute value of life from peoples’ decisions
Many use wage differentials: how much higher wages are required for risky jobs compared to safe jobs?
Some papers look at other decisions Decisions to speed, wear seatbelts, buy smoke detectors, smoke
cigarettes Decision to live in very polluted areas (comparing property values) Prices of newer, safer cars versus older, more dangerous ones
Some used surveys to ask people who they would make hypothetical money-safety tradeoffs
Each paper reaches some estimate for implicit value people attach to their lives
Kip Viscusi, The Value of Risks to Life and Health
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What does Viscusi find? Wide range of results Most suggest value of life between $1,000,000 and $10,000,000 Many clustered between $3,000,000 and $7,000,000
Even with wide range, he argues this is very useful: “In practice, value-of-life debates seldom focus on whether the appropriate
value of life should be $3 or $4 million… However, the estimates do provide guidance as to whether risk reduction
efforts that cost $50,000 per life saved or $50 million per life saved are warranted.”
“The threshold for the Office of Management and Budget to be successful in rejecting proposed risk regulations has been in excess of $100 million.”
C&U: National Highway Traffic Safety Administration uses $2.5 million for value of traffic fatality in cost-benefit analysis
Kip Viscusi, The Value of Risks to Life and Health
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Viscusi’s findings: papers using wage differentials
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Viscusi’s findings: papers using wage differentials
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Viscusi’s results: papers using other tradeoffs
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Viscusi’s results: papers using survey data
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Back toother topics
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Damage awards vary greatly across countries, even across individual cases
We saw last week: 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
Inconsistency of damages
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What we’ve discussed so far: compensatory damages Meant to “make victim whole”/compensate for actual damage done
In addition, courts sometimes award punitive damages 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”
Punitive damages
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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 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
Punitive damages
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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…
Example of punitive damages: Liebeck v McDonalds (1994) (“the coffee cup case”)
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Stella Liebeck dumped coffee in her lap while adding cream/sugar 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 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
Liebeck v McDonalds (1994)
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Rule in place was comparative negligence 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
Liebeck v McDonalds (1994)
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We’ve said all along: with perfect compensation, incentives for injurer are set correctly. So why punitive damages?
Example… 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
What is the economic purpose of punitive damages?
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Punitive damages should be related to compensatory damages, but higher the more likely injurer is to “get away with it” 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 cost-benefit analysis of chance of being caught
This suggests…
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Some empirical observations about tort system in the U.S.
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In 1990s, tort cases passed contract cases as most common form of lawsuit 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… 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
U.S. tort system
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Punitive damages historically very rare 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 Civil suits generally require “preponderance of evidence” In many states, punitive damages require “clear and convincing”
evidence
U.S. tort system
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Medical malpractice 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
U.S. tort system
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Product liability 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” Manufacturer is liable if product determined to be defective Defect in design Defect in manufacture Defect in warning
U.S. tort system
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Most vaccines are weakened version of disease itself 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 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
Vaccines
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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) Impossible to establish which firm produced dose given to a particular
woman California Supreme Court introduced “market share liability”
Class action lawsuit 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…
Mass torts
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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
Cooter and Ulen’s overall assessment of U.S. tort system
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“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.”
To wrap up tort law, a funny story from Friedman…
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