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Lecture

Textbook Notes- Chapter 9 Topics in the Economics of Tort Liability

8 Pages
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Department
Economics
Course Code
ECO320H1
Professor
Robert Barber

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Chapter 9 t Topics in the Economics of Tort Liability
Goal of Tort: minimize sum of cost of harm form accidents, costs of avoiding accidents, and costs of
admin.
Core Assumptions:
1. Rationality t for tort liability to have the effect on injurers, those injurers must be rational
- W}ouWíu}}oµv]uZ}µv}(o}Á}]o]ÇÀv~ZZÇÁ]oo
vÀZv[Uîu}}oÆPPZ}]o]Ç}(]vÁ]Z}v]o
catastrophic outcomes
- Common Cause of the 2 problems (=misperceived probabilities): frequency and vividness with
which people are reminded of these risks (e.g. infrequent/dull reminders of risk =
underestimation)
- With inaccuracy in making assumptions, }ov[ul}]oµo]}v}(v
benefits and costs that economic theory assumes they make
- Issue between unilateral vs. bilateral precaution
- LAPSES (clumsiness/inattention/misjudgment/misperception/weakness of will that cause
accident) cause unintended negligence, which causes accident (e.g. motorists and speed limits =
momentary lapses)
*figure 9.1 t probability of lapse causing negligent precaution graph
o Moral luck Á]Z}o]]o]ÇW^Z]vooÇÁv}}o}ÁZ]PZ]u
}o]]o]Ç_ Æ role of moral luck would be reduced if rule of liability for accidents
caused by negligence was replaced with one caused by INTENTIONAL negligence
(DOWNFALL: required plaintiff to prove a lot more)
2. Regulation t liability vs. (safety) regulation
- Regulation = ex ante enforcement by administrators (e.g. fines)
- Liability = ex post enforcement by victims (courts)
- Difference between administrators and courts:
o Admin = technical knowledge about specialized industries (admin can set standards
better than courts t e.g. safety regulations)
o Courts = trials can provide better info about harm caused by accident to judges/juries
than administrators can predict
o Courts = fewer political motives
Regulators may set standards too low to avoid liability for politically powerful
businesses (court imposed standard of care > safety regulations)
o Admin = set standards too high in order to reduce competition
- Safety regulations Æ rich source of bribes for corrupt officials
- Countries with admin MORE political/corrupt than judges, liability (adv.) > regulation
- d}o]]o]ÇE]v[ÁoZA]viµE<ZhWd
- Industries with undercapitalized firms risk bankruptcy (THEREFORE safety regulation (adv.) >
liability)
www.notesolution.com
o Collect fines before accident occurs (forces undercapitalized firm to comply with safety
standards that would otherwise be violated under a liability rule)
- Administrative costs of regulations and liability
o Small harm on large group = safety regulations (adv.) > liability Æ cost of court trial >
admin proceeding
3. Insurance t claim for compensation/recovery ~v(~ZÆvo]Ì[]l(}u]vµÇ}
insurer)
- Accident victim can recover twice t from insurer AND injurer
o Z^µ}P]}v[t u]v}vZv(À]]u[}ÀÇ]PZ}]vµv
company (insurer stands in the place of insured)
- /vµvP]v]voZu~À]]u[]vµvÀX]vµvP]vo]]o]Ç~]v[
insurance)
- Complete vs. incomplete compensation
o Insurance = private system of liability law that reallocates costs of accidents according to
contracts between insurer and insured
o As private systems Æ complete, injurers/victims deal more directly with their insurance
Co., less with each other (leads people to care more about insurance rates/terms of
coverage, less about underlying law of accidents)
- Insurance premium = revenues
- Insurance process claims and pay them = cost of doing business
- Perfectly competitive markets: profits = 0 (premiums = claims +admin costs)
- ^]vÇu}(µv]Ào]vµvv}u]]À]vµvulUZP}o}(}law can
]u]v]u]vPZ}o}}(]vµv}}o]ÇZ}o_
o ZZµo}(E}>]]o]Ç[t potential victims buy accident insurance, potential injurers =/=
need for liability insurance (cause victims to buy relatively more insurance(?))
o Z^]>]]o]Ç[t potential victims =/= need for accident insurance, potential injurers
buy liability insurance (cause injurers to buy relatively more insurance(?))
- Externalizing risks gives insurer incentive to REDUCE precaution
o MORAL HAZARD t reduction in precaution
o Ways to Reduce Moral Hazard as employed by insurance companies:
1. Deductible t insured pays fixed $ amt of his accidental losses
2. Co-insurance t insured pays fixed % of his accidental losses
3. Experience Rating t insurance company sets the insured[}]vP}Z
experience of the insured claims (e.g. claim in Yr 2 = increased rate in Yr 3)
4. Liability insurers impose safety standards that policy holders must meet to remain
covered by insurance (e.g. fire insurers required that businesses have fire
extinguishers before any claims can be made); insurance safety standards = private
regulations imposed by contract and enforced by private parties VS. Public
regulations = imposed by law and enforced by state officials
- Efficiency of insurance markets: Rule of strict liability (adv.) > no liability (many claims trigger
surcharge =/= discount)
www.notesolution.com
o E.g. under strict liability Æ Co. makes defective products and makes many claims to its
insurer BUT pays higher rates (experience rating), THEREFORE creates incentives for
more precaution by manuf. to reduce its claims by reducing consumer accidents
o Pµuv'/E^d]o]]o]ÇW]}À]}vµuÁ]ZZµvÁv]vµv[
(insurance that consumers would not voluntarily buy)
Tort liability system effectively provides consumers w/ insurance against pain
and suffering that they would not buy for themselves (pain/suffering
compensation = unwanted insurance)
- Instability of insurance industry and supply of insurance: (Insurance Crisis)
o íXZÀ[ZoÇinsurance company (insurance companies use premiums in the
years with no claims to build up reserves t e.g. earthquakes
Insurance Co. w/ excess reserves = able to expand supply of insurance at little
cost (if no excess reserves, must increase reserves to write more insurance
policies) PROBLEM: changing level of reserves can be costly b/c of tax
consequences; insurance Co. can exhaust their reserves
o îX^À^o]}v_t increase in insurance premiums drives out good risks and
retains bad risks
Insurance Crisis: Increased claims set off a cascade of increased premiums due
to adverse selection
4. Bankruptcy (liability escape route)
- Strict liability Æ firm internalizes social cost of accidents Æ chooses socially optimal activity and
care levels (BANKRUPTCY CHANGES THIS)
- W}v]ouPE(]u[vÁ}ZU(]uydZE>/^}(Z]lU}]vv]À}
take precaution & restrain activity level
- StrP]vPÁ]ZZµ}((µµo]]o]]Zv]][vlµÇ = continuous distribution
of profit & remaining undercapitalized; declare bankruptcy to avoid compensation
o Risky industries = many accidents, little capital = lowered production and distorted
capital labor ratio
o PROBLEM: avoiding liability through insolvency causes significant inefficiencies (harms
reputation)
- New judgment-proofing techniques (enables Corps to avoid tort liability without being
undercapitalized): [DISTORTION OF INCENTIVES FOR PRECAUTION]
1. ^µ]]Ç~^]Z}}À]o_t e.g. Exxon Valdez
2. Priority of creditors t µEµvµ~XPXovP}]}v}(}X[}
µ]}A(]uZ]o[oP}]}v}(](}uo]u}(}À]tims)
3. ^µ]]Ì]}v_t firms convert expected income (e.g. AR) into securities and sell them to
investors so tort victims cannot tap into this income as a source of compensation
o SOLUTIONS (imperfect): compulsory insurance, posting bond, replacing ex post liability
with ex ant regulations
www.notesolution.com

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Description
Chapter 9 J Topics in the Economics of Tort Liability Goal of Tort: minimize sum of cost of harm form accidents, costs of avoiding accidents, and costs of admin. Core Assumptions: 1. Rationality J for tort liability to have the effect on injurers, those injurers must be rational - 9}oKZ9K}Z}oLZ]KZ} L }o}}]o]LZ~ZZ]oo LZL[7K}Z}o22Z}]o]} ]LZ]Z}L]oo catastrophic outcomes - Common Cause of the 2 problems (=misperceived probabilities): frequency and vividness with which people are reminded of these risks (e.g. infrequentdull reminders of risk = underestimation) - With inaccuracy in making assumptions, }o L[Kl}] o o]}LZ}L benefits and costs that economic theory assumes they make - Issue between unilateral vs. bilateral precaution - LAPSES (clumsinessinattentionmisjudgmentmisperceptionweakness of will that cause accident) cause unintended negligence, which causes accident (e.g. motorists and speed limits = momentary lapses) *figure 9.1 J probability of lapse causing negligent precaution graph o Moral luck ]ZZ }o]]o]9^Z ]LooL}}Zo}EZZ]2Z]K }Z o]]o]_ role of moral luck would be reduced if rule of liability for accidents caused by negligence was replaced with one caused by INTENTIONAL negligence (DOWNFALL: required plaintiff to prove a lot more) 2. Regulation J liability vs. (safety) regulation - Regulation = ex ante enforcement by administrators (e.g. fines) - Liability = ex post enforcement by victims (courts) - Difference between administrators and courts: o Admin = technical knowledge about specialized industries (admin can set standards better than courts J e.g. safety regulations) o Courts = trials can provide better info about harm caused by accident to judgesjuries than administrators can predict o Courts = fewer political motives Regulators may set standards too low to avoid liability for politically powerful businesses (court imposed standard of care > safety regulations) o Admin = set standards too high in order to reduce competition - Safety regulations rich source of bribes for corrupt officials - Countries with admin MORE politicalcorrupt than judges, liability (adv.) > regulation - @}o]]o]-]LE[ZoZ)]LE - liability) www.notesolution.com
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