Relaxing the Model’s Assumptions

Assumption Reality Effect

Rationality Systematic behavioral errors

Wrong # of accidents

Injurers are solvent and pay full damages

Bankruptcy places limit on damages paid

Too many accidents

No Insurance Insurance (with deductible/copay)

Moral hazard?

No social policies designed to reduce external costs

OSHA, FDA, CPSC, EPA

?

Litigation costs are zero Costs > 0 for both sides

?

Other Extensions of the Model Vicarious Liability

Being held responsible for harm caused by others

Employer for the employee Parent for the child Bartender for the drinker

Joint and Several Liability Multiple injurers can be held liable for full

damages Makes it easier for victim to sue and collect full

damages (deep pockets)

“acting within the scope of employment”“acting within the scope of employment”

Computing Compensatory Damages Indifference Approach

Injury + damages = no injury Hand Rule Approach

How much are you WTP to avoid death? Hand Rule: B = pL

Other Extensions of the Model

Joe works a job where he might be exposed to a chemical that increases the probability of death from .01 to .02 in 20 years. Joe would pay $15,000 to avoid this risk (or accept $15,000 to take on the risk). Joe is accidently exposed and dies after 20 years. What are Hand Rule damages for Joe’s heirs?

Implied Value of a Statistical Life from Recent Labor Market StudiesStudy VSL in 2000 ($ millions)

Moore and Viscusi (1990) 20.8

Kniesner and Leeth (1991) 0.7

Gegax, Gerking, and Schulze (1991) 2.1

Leigh (1991) 7.1 – 15.3

Berger and Gabriel (1991) 8.6 - 10.9

Leigh (1995) 8.1 – 16.8

Dorman and Hagstrom (1998) 8.7 – 20.3

Lott and Manning (2000) 1.5 – 3.0Source: Table 7.2, p. 145, Field and Field (2006)

Computing Compensatory Damages Indifference Approach

Injury + damages = no injury Hand Rule Approach

How much are you WTP to avoid death? Hand Rule: B = pL

Lost Income

Other Extensions of the Model

Wrongful Death Economic Damages ReportDecedent: John Doe

Report Produced on 05/10/2000

Case Information

Trial Date: 05/30/2000 Date Damages Began: 11/18/1996

Compound Interest Rate: 0.0666 (for Past Damages) Discount Rate: 0.0666 (for Future Damages)

Decedent Information

Sex: Male Race: White

Birth Date: 05/31/1948 Age at Death: 48

Retirement Age: 65 Expected Age at Death: 77

Employment: Fenton Art Glass Dependent: Mary Doe (d.o.b. 06/22/93)

Damages Summary

Present Values

Type of Damage Pre-Trial (Past) Post-Trial (Future)

Lost Earnings $ 90,630.62 $ 199,462.28

Lost Fringe Benefits $ 26,279.65 $ 58,841.37

Lost Household Services $ 12,078.93 $ 29,069.77

Other Damages $ 18,275.61

Total Damages $ 147,264.81 $ 287,373.42

Grand Total Damages $ 434,638.23

Punitive Damages For behavior that is “malicious, oppressive, gross, willful

and wanton, or fraudulent” Should bear a “reasonable relationship” to

compensatory damages

Other Extensions of the Model

Liebeck v McDonalds (1994) Drive-through coffee; parked to add cream, coffee spilled on lap

for 90 seconds 3rd degree burns (8 days in hospital, skin grafts, 2 yrs of treatment)

Initially sought $20,000 damages (to cover $11,000 in medical costs); McDonalds offered $800. Went to court.

Trial McDonalds serves coffee at 180°-190° F Liebeck showed that 180° coffee can cause 3rd degree burns in 12-15

seconds (lowering the temp. would allow victims more time to react) McDonalds received 700 prior complaints of burns (and settled with

some victims) McDonalds quality control manager testified the frequency of injuries

was not sufficient to cause McDonalds to alter practices Jury used comparative negligence and found McDonalds 80% liable.

Compensatory damages set at $200,000, which they reduced to $160,000. Punitive damages set at $2.9 million.

Judge reduced punitive damages to 3x compensatory, making total award $640,000.

During appeal, parties settled out of court.

Punitive Damages For behavior that is “malicious, oppressive, gross, willful

and wanton, or fraudulent” Should bear a “reasonable relationship” to

compensatory damages

Optimal punitive award depends on enforcement error L = Ae where e = enforcement error = fraction of victims that sue

Other Extensions of the Model

Guidant is a medical equipment manufacturer. Suppose that Guidant is sued by Mr. Jones for $50,000 for damages associated with a pacemaker. Suppose also that Guidant has made $500 worth of profits on each pacemaker sold, it has sold 10,000 pacemakers, and that 6 other people have been damaged by Guidant’s pacemakers. Because the reward is so small, none of the other people have sued. In this case, how should punitive damages be set to compensate for an enforcement error?

A = ($50,000)(7) = $350,000 e = 1/7

L = Ae = ($350,000)(1/7) = $50,000

L* = Aem = ($50,000)m = $350,000

Implies that m = 1/e = 7

m = punitive multiple

Empirical Assessment of Tort Law

Case Type Total Percent

Total 5,929,537 100%

Domestic Relations 2,448,150 41

Small Claims 732,977 12

Contracts 639,783 11

Estates 606,722 10

Torts 572,041 10

Real Property rights 439,947 7

Civil appeals 93,339 2

Mental Health 90,608 2

Other 305,970 5States include: AK, AZ, CA, CO, CT, FL, HI, ID, IN, KS, ME, MD, MA, MI, MN, MO, NV, NJ, NM, NY, ND, OH, OR, TN, TX, UT, WA, WI, WY.

Source: Court Statistics Project, National Center for State Courts, 1995.

Empirical Assessment of Tort Law Other findings:

Majority were auto torts 75% of cases were settled out of court; 3% decided at trial 30% were uncontested 50% disposed within 14 months

Percent of trial verdicts in favor of plaintiffs or defendants

Winner All Cases Auto Medical Malpractice

Premises

Plaintiff 53% 60% 26% 52%

Defendant 45 36 74 47

Mixed 2 5 0 1

Number of cases 9,553 4,162 1,148 2,212

Source: Court Statistics Project, National Center for State Courts, 1995.

“Data Watch: Tort-uring the Data,” with Jonathan Klick and Alex Tabarrok, Journal of Economic Perspectives. 19(2):207-220, 2005.

Highway Fatality Rates

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1975 1980 1985 1990 1995 2000 2005 2010

Fat

alit

y R

ates

Fatality rates per 100 million vehicle miles

Urban

Rural

http://www.bts.gov/publications/national_transportation_statistics/

Contract Law Questions

Using an “economic theory of contract” we would enforce:

a) b) c) d)

0% 0%0%0%

a) All the contract that the classical bargain theory enforces.

b) Those contracts that make both parties better off at the time that the agreement is reached.

c) All contracts by using specific performance.

d) All contracts that include elements of offer, acceptance, and consideration.

The case Hadley v Baxendale (1854) is famous for its illustration of:

a) b) c) d)

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a) The doctrine of forseeabilityb) The Coase Theorem.c) Perfect expectation damagesd) Mutual mistake

Society wants the promisor to breach when:

a) b) c) d)

0% 0%0%0%

a) The promisor’s cost of performing > promisee’s benefit from performance

b) The promisor’s cost of performing < promisee’s benefit from performance.

c) The promisor’s cost of performing > promisor’s liability from breaching

d) The promisor’s cost of performing < promisor’s liability from breaching

Let A contract to buy a custom made machine from B for $100 to be paid upon delivery. Delivery is expected in three months. A expects to earn $20 in profits after deducting the contract price and reliance of $10 and B expects to earn $10 in profits after deducting its expected costs. A’s reliance expenditures, however, turn out to be $40 not $10. According to the efficient breach/performance decision, the following statement can be made.

a) b) c) d)

0% 0%0%0%

a) A should breach if B’s costs are greater than $100 so that it is also a losing contract for B

b) Since this is a losing contract for A, it may be efficient for A but not B to breach

c) It is efficient for B to breach if its costs are greater than A’s negative lost profits plus the contract price of $100

d) No general statement can be made about the efficient breach decision because the parties should not have entered a losing contract in the first place

Bob has been on the market for rare “alternative medicine” books for quite a while. After expending considerable time and money in finding such a book, he has agreed to purchase a unique volume on aromatherapy from Dan for $10,000. After agreeing to the contract, Dan decides to renege and not deliver the volume to Bob. He offers to give Bob his money back and call it a day. As a consultant on this case interested in economic efficiency, you would recommend that:

a) b) c) d)

0% 0%0%0%

a) Bob be given the volume.

b) Dan retain the volume and give Bob his money back. Bob can then purchase

another book c) Dan retain the volume and give Bob his

money back plus perfect expectation

damages d) The Coase Theorem be called into action

and that the book be given to either party, since the courts cannot ever improve on

social welfare

Calabresi and Melamed suggest that when the costs of writing and enforcing a contract are high

a) b) c) d)

0% 0%0%0%

a) Courts should award perfect expectation damages in order to reduce court costs

b) Courts should award specific performance and let the two parties bargain

c) Courts should award perfect expectation damages to reduce the transaction costs of multiple transfers of the good

d) The Coase Theorem suggests that the legal rule will not matter

Tort Law Questions

a) Adverse selectionb) Moral hazardc) Vicarious liabilityd) An intentional tort, and

therefore a crime

Economists believe that many people drive less carefully after purchasing car insurance. Such behavior would be classified as:

a) b) c) d)

0% 0%0%0%

Under a rule of comparative negligence, the damages awarded to the victim:

a) b) c) d)

0% 0%0%0%

a) Are reduced to zero if the victim was negligent compared to the injurer.

b) Include punitive damages when the injurer was more negligent than the victim.

c) Are reduced if the victim was also negligent.

d) Are based on the comparative wealth of the victim and the injurer.

a) Including activity level changes in the burden of precaution (B).

b) Substituting incremental for total values in the formula’s variables.

c) Substituting the marginal cost of care for B but leaving unchanged the benefit side of the formula.

d) Adjusting the probability of an accident for the amount of the victim care.

e) Making explicit the causal connection between the probability of an accident and the burden of precaution.

To make the Hand formula an economically correct statement of negligence requires

a) b) c) d) e)

0% 0% 0%0%0%

Economics predicts that negligence would be more efficient than strict liability

a) b) c) d)

0% 0%0%0%

a) when injurers have more information about accident prevention than victims

b) when there are large differences among injurers in the costs of taking care

c) when a reduction in the victim’s activity level is the efficient way to prevent an accident

d) when the cost of victim precautions is greater than the reduction in expected damages from these precautions

The economic argument for holding a gun manufacturer vicariously liable for the intentional torts of its customers is the following:

a) b) c) d)

0% 0%0%0%

a) the manufacturer is in a better position to monitor its customers actions than the victim of the tort.

b) customers typically lack the wealth to pay for the damages they cause whereas manufacturers have deep pockets.

c) enforcement resources are saved because it is cheaper to sue one manufacturer than many customers.

d) the manufacturer will include its expected liability cost in the price of the product so customers, in effect, pay for their torts.

Suppose there is a chance that a child playing in the area of a construction project might fall in a large hole and injure itself. Constructing a fence around the project will prevent such an accident. Assume the harm from such an accident is $100,000, the probability of an accident equals .01 during the construction period, the cost of a fence is $5000, the contractor expects a profit of $25,000, and all parties are risk neutral. Strict liability will be inefficient because

a) b) c) d) e)

0% 0% 0%0%0%

a) the contractor will install the fence which reduces expected wealth by $5000.

b) it creates no incentive for children or their parents to take efficient levels of care to avoid an accident.

c) the contractor may shut the project down rather than face a potential liability of $100,000.

d) the contractor will install the fence under strict liability but not under negligence.

e) all of the above.