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					      Econ 522
   Economics of Law


Dan Quint
Fall 2009
Lecture 19
           Midterm 2
          Question 3a

“Explain why expectation damages
     lead to efficient breach”


                                   1
     In this class, we generally ask two distinct
     questions
           What actions                        What do we expect
         would be efficient?                  people to actually do?

        Social              Social             Private             Private
                     vs.                                     vs.
        Cost                Benefit             Cost               Benefit

Example: promisor’s decision to perform on contract
        Promisor’s          Promisee’s          Promisor’s          Promisor’s
          cost of    vs.   benefit from           cost of    vs.   liability from
        performing         performance          performing            breach

     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                         2
     In this class, we generally ask two distinct
     questions
            What actions                           What do we expect
          would be efficient?                     people to actually do?

         Social               Social               Private              Private
                      vs.                                        vs.
         Cost                 Benefit               Cost                Benefit

Another example: injurer precaution under strict liability
           Cost of          Reduction in              Cost of           Reduction in
           injurer    vs.    expected                 injurer    vs.     expected
         precaution            harm                 precaution            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                   3
   Back to work:
more twists on liability




                           4
 Vicarious Liability


 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

                                                              5
 Vicarious Liability


 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


                                                          6
 Vicarious Liability


 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…

                                                                                  7
 Joint and Several Liability


 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
                                                                            8
 Joint and Several Liability


 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



                                                                                9
 Comparative Negligence


 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?
                                                                     10
 Comparative Negligence and Evidentiary
 Uncertainty

 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

                                                                     11
 Comparative negligence and evidentiary
 uncertainty

        $




                          Comparative negligence,
                          evidentiary uncertainty


                                                    evidentiary uncertainty
                          Any negligence rule
                                                    Simple negligence,
                                                                                  wx + p(x) A
                                                                                  wx


                                                                                  p(x) A

                                         x*                                   x

 Comparative negligence mitigates effect of evidentiary
  uncertainty
                                                                                                12
  Perfect
Compensation




               13
 Perfect compensation


 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



                                                                   14
 Perfect compensation

 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.”
                                                                           15
 One other odd feature of compensatory
 damages…

 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

                                                                   16
What’s a life
 worth?




                17
 What’s a life worth?

 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
                Regulation             Estimated cost per life saved
 Airplane cabin fire protection            $       200,000
 Car side door protection standards        $      1,300,000
 OSHA asbestos regulations                 $    89,300,000
 EPA asbestos regulations                  $   104,200,000
 Proposed OSHA formaldehyde standard       $72,000,000,000


 Regulators need to decide “where to draw the line”                   18
 Kip Viscusi, The Value of Risks to Life and
 Health

 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                        19
 Kip Viscusi, The Value of Risks to Life and
 Health
 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                    20
 Kip Viscusi, The Value of Risks to Life and
 Health
 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                                     21
 Kip Viscusi, The Value of Risks to Life and
 Health
 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
                                                                           22
       million for value of traffic fatality in cost-benefit analysis
Viscusi’s findings: papers using wage
differentials




                                        23
Viscusi’s findings: papers using wage
differentials




                                        24
Viscusi’s results: papers using other
tradeoffs




                                        25
Viscusi’s results: papers using survey data




                                              26
  Back to
other topics




               27
 Inconsistency of damages


 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


                                                                           28
 Punitive damages


 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”
                                                                   29
 Punitive damages


 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




                                                                          30
 Example of punitive damages: Liebeck v
 McDonalds (1994) (“the coffee cup case”)

 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…




                                                         31
 Liebeck v McDonalds (1994)

 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                                 32
 Liebeck v McDonalds (1994)


 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
                                                                       33
 What is the economic purpose of punitive
 damages?
 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                                                         34
 This suggests…

 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
                                                                        35
Some empirical observations
about tort system in the U.S.




                                36
 U.S. tort system


 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                                         37
 U.S. tort system


 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
                                                                     38
 U.S. tort system


 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




                                                                      39
 U.S. tort system


 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
                                                                        40
 Vaccines


 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
                                                                       41
 Mass torts


 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…
                                                                          42
 Cooter and Ulen’s overall assessment of
 U.S. tort system

 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

                                                             43
To wrap up tort law, a funny story from
Friedman…

 “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.”
                                                                    44

				
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