ECON2120 Lecture 4: Topic 4
TOPIC 4: TORTS
7.2 ACCIDENTS BETWEE N STRANGERS
- Can tort law produce an efficient amount of accidents?
- How do different liability rules affect incentives to reduce accident risk?
The costs of accidents in Australia
- Traffic accidents impose large costs e.g. Dept. of Infrastructure and Regional Development estimates that
annual economic cost of road crashes in Australia at $27 billion (1.5% per cent of GDP). That comes to
10.8 cents per vehicle kilometre.
- Total cost of work place injuries was estimated at $28.2 billion in 2012-13
The law and economics analysis of accidents
- Will focus on motor vehicle accidents
- We consider accidents between strangers (i.e. not in a contractual relationship). Now we are in a
situation where transactions costs are prohibitive and bargaining cannot take place, so the courts use
liability rules.
- The economic analysis of accidents starts with the observation that they are not entirely accidental.
- People do not choose to have accidents, but they can take precautions to reduce the probability and
severity of accidents e.g. not speed, not drive drunk, not text, get brakes checked, look both ways when
crossing the road. Driver care matters.
- What set of legal rules will lead to efficient decisions?
o Direct regulation? Pigouvian taxes? Penalties for risky activities e.g. speeding fines?
o Require much information that is impossible to collect
o Charge by results: if I cause an accident I must pay the cost
o Accidental injuries between strangers come under tort law
Three roles of law
- Can be seen as an Pigouvian Tax to internalise externalities
o I take an action that imposes costs on you
o You sue
o I make good the damage
o So the externality is internalized
- Involves private law enforcement
o You figure out who injured you, prosecute him
o The fie he pay goes to yo
o To reward you for catching him
o Can be seen as a bounty to law enforcers
- Can be seen as compensation and insurance
o You get injured
o The tortfeasor must make good the loss
o Thus effectively insuring you
find more resources at oneclass.com
find more resources at oneclass.com
- The law and economics approach takes the objective of the legal system for accidents as minimising their
total social costs: the costs of precaution, the costs of injuries that nonetheless occur (the expected cost
of harm), the costs of administration (such as litigation costs) and the costs of risk bearing.
- Equivalently we maximise the net benefits from the activity.
- Efficient Accidents
o The ojetie is ot zero traffi aidets
▪ We could get that by not driving
o We want only efficient accidents, which means:
▪ Each party should take those precautions → that save more in expected accident costs
than the precaution costs
o If I face the full social costs of my actions, it is in my interest to take all cost justified
precaution.
- Assumptions
o All these assumptions will be relaxed at some stage
o Accidents between strangers (no contractural relationship). A victim and an injurer
o Only the victim suffers damage (e.g. a pedestrian and a driver). That is unilateral damage.
o Assume an interior solution is optimal (not efficient to have no cars or no pedestrians)
o Administrative costs are zero (e.g. we ignore litigation costs, but will examine them in the
graduate section)
o The parties are risk neutral. That is, they care about the expected value of outcomes – the
value times probability of occurance
o E.g. a risk-neutral person who faces a liability of $100,000 with probability 10% will consider
this uncertain payment to be equivalent to a certain payment of its expected value of $10,000.
This means no risk bearing costs.
o The amount that a liable injurer must pay a victim is KA damages. We assume that court
awards damages equal to harm caused, damages are fully compensatory
o Unilateral care model: ol the ijurers eerise of are or preautios affets aidet risks;
itis ehaiour does ot. E.g. ol driers speed affets epeted har
o We are keeping the participation in the activity fixed (e.g. total km driven, so this is the costs
per trip, or per km)
Polinsky accident example
Table 3 Automobile accident example – Driers are affets epeted aident cost
- The efficient outcome is to drive moderately.
- Legal liability for accidents governs the circumstances under which parties who cause harm to others
must compensate them. Courts can impose different levels of liability: no liability (accident costs remain
where they fall), strict liability and negligence
- Under no liability, the driver drives rapidly – an inefficient outcome
find more resources at oneclass.com
find more resources at oneclass.com
- Under no liability, an injurer must always pay a victim for harm due to an accident he causes. The driver
is liabile for pedestrias aidet losses regardless of his are
- The drier ears o osts, is liale for the pedestrias osts, so ears the total ost of the aidet.
Internalised the externality.
- So it is in his interest to take all precautions worth taking to minimise the social costs of accidents
(maximise benefits from the trip)
- But this assues the ourt a otai orret iforatio aout the itis daages. “uppose the ourt
always underestimates actual damages, say it awards only ½.
- The the driers net benefits (benefit less expected damage payment) would be $70 = $120-$50 if drives
rapidly, $60 ($80-$20) if drives moderately and $40 if drives slowly. He will drive rapidly – and will get
more crashes than is efficient.
- If the court always estimates daages as tie hat the atuall are, the the driers et eefits are:
-$80 (120-200), $0 (80-80) and 10 (50-40). So would drive too slow – and have to few crashes.
- So strict liability will only lead to efficient outcomes if the court is expected to set the itis daages
at the correct level
The rule of negligence
- Main basis for liability for damage from accidents is the tort of negligence
- It most a duty to take reasonable care to avoid acts or omissions which you can reasonably foresee would
be likely to injure another
- Under the negligence rule, an injurer must pay for harm cuased only when he is found negligent, that is,
only when his level of care was less than a standard of care chosen for the courts, often referred to as
due care
- If the standard of due care is set at the efficient level of care (driving at moderate speed), then the driver
is liable only if he drives rapidly
- The efficient standard of care ensures the injurer is liable for the accident unless he took all cost-justified
precautions to prevent it.
- If he drives rapidly, the benefit net of expected liability payments is $20 ($120 less $100 expected liability
payment. If he drives moderately the driver receives $80 (there is no liability), and slow $50 (again, just
the driers eefit. He ill drie oderatel.
- The injurer has an incentive to comply with the standard of care – to avoid liability. If the standard and
damages are set accurately, we get efficient behaviour. The drive ris liable if he did not take all costs
justified precaution
- If he doest, he ears all of the osts
- Which makes it in his interested to take all cost justified precautions so he is not liable
- An efficient level of precautions make him not negligent, not liable. The driver chooses the efficient
outcome under the rule of negligence.
- The court needs enough information to determine the efficient outcome, so it can set the standard of
care appropriately. E.g. say it sets the standard to strict (makes slow driving the standard of care), then
this net benefit is $40 ($80-$40)if drives moderately and $50 if drives slowly. We will get an inefficient
outcome
- Or if sets the standard too lax, may drive fast
- So in unilateral accidents, both strict liability and negligence are efficient.
find more resources at oneclass.com
find more resources at oneclass.com
