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textbook notes


Department
Economics
Course Code
ECO320H1
Professor
Robert Barber

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Chapter 8: An economic theory of tort law
What is tort law? Tort law occurs when there is a breach of a duty owed to society. It occurs
when the victim cannot sue under property law because it does not involve property, nor contract
law, because the parties did not enter into any contract. The most common examples of tort law
cases involve auto accidents, slander/libel, product liability, environmental pollution, etc.
Tort law is usually unintentional harm; intentional torts are usually crimes.
Tort law exists because the costs of bargaining for some kinds of harm are so high that parties
cannot cooperate together. Example: every drive cannot negotiate with every other driver to
allocate the costs of future accidents. Nor can every driver enter into a contract with every other
person that might be injured. Another reason is when absolute costs are low, but relative costs are
high. Example: Three hunters go hunting. Before hunting, they could negotiate an agreement to
allocate cost of an accident; however the probability of an accident is low, so cost of negotiating
is high.
Economic purpose of tort liability is to induce injurers and victims to internalize the costs of
harm that can occur. The economic essence of tort law is its use of liability to internalize
externalities created by high transaction costs.
Traditional theory of torts:
Three elements must be present for plaintiff’s recovery:
1. The plaintiff must have suffered harm. For example, the owner of a car with a
conventional carburetor cannot be compensated if the manufacturer sells carburetors, but
only the turbocharged ones are defective. Courts trying to internalize costs often use
perfect compensation, but it is hard to implement because the value of intangible harm
(such as death) is hard to estimate.
2. The defendant must have caused the harm. For example, if the two hunters both shoot the
third hunter accidentally, only the one who actually did damage is liable. The ‘but-for’
rule decides whether event A caused event B: But for A, would B have occurred? In a
series of multiple events, the approximate cause is the most proximate event (the event
that is closest to the one causing the harm).
3. The defendant must have breached his duty. In short, the defendant must have been at
fault, or ‘negligent. Some fault is binary (yes or no), but some is continuous (a car can
change speed continuously). The legal standard of care is the minimum acceptable
standard of precaution. This is the standard of precaution areasonable person would
take (ie. Driving at or less than the speed limit).
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Minimizing social cost:
Let the probability of an accident = p. Then, p=p(x) is a decreasing function of x. A is the value
of the harm. Thus, A*p(x) is the expected cost. Let wx represent the cost of precaution, which is
increasing. The Social Cost, SC = wx + A*p(x). The efficient level of precaution, x*, is when the
marginal social cost equals the marginal social benefit (w = -A*p’(x)). The cost of precaution
may be different for the injurer and the victim. For example, if software fails, the manufacturer
must design better software, which takes time and money, but the victim only has to back up their
hard drive. In this case, taking precaution is cheaper for the victim than for the injurer.
Strict liability / no liability:
The rule of no liability causes the victim to internalize the marginal costs and benefits of
precaution, which gives the victim incentives for efficient precaution. Under this rule, the injurer
has no incentive to take precaution, because the victim bears all the cost.
The rule of strict liability with perfect compensatory damages gives the victim no incentive to
take precaution. This is because all liability is assigned to the injurer no matter what. However,
this rule causes the injurer to internalize the marginal cost and benefits of precaution, which
gives them incentive to take efficient precaution.
No liability gives victim incentive to take efficient precaution, but the injurer will take
none.
Strict liability gives injurer incentive to take efficient precaution, but the victim will take
none.
Under simple negligence, negligence + contributory negligence, strict liability +
contributory negligence, or comparative negligence, both the injurer and victim have
incentives to take efficient precaution.
Negligence:
Under a negligence rule, with perfect compensation and the legal standard equal to the efficient
level of care gives the injurer incentives for efficient precaution. The victim also has incentive to
take efficient precaution, because if either injurer or victim falls below the efficient level, they
will bear liability costs.
Simple negligence assigns liability to which party was more at fault (took less than
efficient precaution). If injurer at fault (x < x*), they are liable. Else if injurer was
faultless (x >= x*), they are not liable.
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