1. Econ 522 Economics of Law Fall 2012 Lecture 15
Guest lecturer: John Karl Scholz

2. Recapping our story to date…

3. Our story so far Efficiency
Maximizing total surplus realized by everyone in society
Scarce resources are owned by whoever values them most
Actions are taken if social benefit exceeds social cost
Design a legal system that leads to efficient outcomes
Once we set up the rules, we don’t expect people to act based on what’s efficient
We expect people to do whatever’s in their own best interest
So the goal is set up the rules such that people acting in their own best interest will naturally lead to efficiency
We started this class by defining the notion of efficiency
Basically: the idea of maximizing the total surplus realized by everyone in society
Efficiency requires that scarce resources be owned by whoever values them the most
And that any action should be taken if its total social benefit exceeds its total social cost
We made the claim that we’re interested in designing a legal system that leads to efficient outcomes
What makes this hard?
Once we set up the rules, we don’t expect individuals to act based on what’s efficient
We expect individuals to do whatever is in their own best interest
So the goal is to set up the rules in such a way that people acting in their own best interest will naturally lead to efficiency

4. Our story so far Coase gives us one way to do that
If property rights are clearly defined and tradable, and there are no transaction costs, people have incentive to trade until each resource is efficiently owned
So initial allocation of rights doesn’t matter for efficiency
But if there are transaction costs, we may not get efficiency this way
Led us to two normative views of the legal system:
1. Minimize transaction costs (“lubricate” private exchange)
2. Allocate rights as efficiently as possible
Tradeoff between injunctive relief and damages
Coase gives us one way to do this
Efficiency requires things to be owned by whoever values them the most
Suppose we set up a legal system where things can be bought and sold
If I value something more than you, it’s in my best interest to try to buy it from you
And if you value something less than me, it’s in your best interest to try to sell it to me
So if we both pursue our own selfish best interests, I’ll end up with the object, which is efficient
As long as property rights are clearly defined and tradeable, and there are no transaction costs, people have an incentive to trade until each resource is owned by whoever values it most
(Works for objects; also works for rights, e.g., right to good night’s sleep versus right to have a party next door)
And since this argument doesn’t depend on who starts with what, Coase tells us that the initial allocation of rights doesn’t matter for efficiency, only for distribution
On the other hand, when there are transaction costs – impediments to private bargaining – we may not get to efficiency this way
This led us to two different normative views of the legal system:
One, that the legal system should aim to minimize transaction costs (“lubricate” private exchange, the normative Coase), since if we make transaction costs low enough, efficiency will follow
Or two, that the legal system should aim to allocate rights efficiently (the normative Hobbes), so that less is lost when private exchange fails
The two normative views can roughly be seen as the arguments in favor of the two usual remedies to protect an entitlement: injunctive relief and damages.
Injunctions are simpler for a court to implement, and create clear property rights that the parties can negotiate around when they are allocated inefficiently
Damages are more expensive to implement, but lead to more efficient outcomes when transaction costs are too high to rely on voluntary trade
We then tackled several other questions a property rights system had to answer – what can be owned, what owners can do with their property, who ownership is established, and remedies – and called that property law

5. Our story so far Property law works well for simultaneous trade
Contracts allow for non-simultaneous trade
Contract law can…
Enable cooperation
Encourage efficient disclosure of information
Secure optimal commitment to performance
Secure efficient reliance
Supply efficient default rules and regulations
Foster enduring relationships
Part of what makes property law straightforward is that trade tends to be simultaneous
I give you an apple, you give me $1
However, in some situations, efficient trade can’t be done simultaneously
It might be efficient for me to build you a house
But it would be very complicated/costly for you to pay me each day for that day’s work
Contract law gives us a way to transact when the transaction does not occur all at once – when one of us has to depend on a promise by the other
We saw a number of different purposes contract law can achieve:
It can enable cooperation when it would otherwise be impossible, as in the agency game we analyzed
It can encourage disclosure of information, as we saw in Hadley v Baxendale
It can lead to efficient breach and efficient investment in performance, as we saw in the airplane example
It can lead to efficient levels of reliance, although setting incentives for both efficient breach and efficient reliance is difficult
It can supply efficient default rules and regulations – usually by imputing contract terms most parties would have wanted, but sometimes in other ways
It can foster enduring relationships, which depend less on the court system

6. Our story so far So far, we’ve been talking about voluntary exchange
Coase is predicated on exchange being voluntary for both parties
Contracts are an extension of voluntary trade
Up next: “involuntary trade”
You’re bicycling to class, I’m texting while driving and I hit you
You didn’t want to deal with me, I didn’t want to deal with you…

7. Our story so far To put it another way…
Property law covers situations where transaction costs are low enough to get agreement ahead of time
Exceptions to property law – private necessity, eminent domain – when this isn’t the case
Contract law covers situations when transaction costs are low enough for us to agree to a contract, high enough that we may not want to renegotiate the contract later
Tort law covers situations where transaction costs are too high to agree to anything in advance

8. Tort law

9. An example This is Joseph Gray, former NYC police officer
On Saturday August 4, 2001, at the end of the overnight shift, he had a few beers in the stationhouse parking lot with other officers
At some point, a few of them moved on to a nearby strip club, where he had a bunch more beers – between 12 and 18 in total
Then he hopped in his minivan, to go pick up a coworker before heading back to the station for his next shift
Speeding through Brooklyn drunk, he ran a red light and hit a pregnant woman, her sister, and her son, killing all of them instantly
Clearly, Gray did not want to kill these three people – in fact, along with theirs, his life was pretty much ruined
At the same time, something horrible happened, and his choices clearly contributed to it happening
We can put aside questions of justice and retribution – the idea that morally, Gray needed to be punished for what he did – and simply consider incentives
Drunk driving (and hitting pedestrians) clearly imposes a pretty serious negative externality on others
So without any laws in place, we would expect to see way more drunk driving than the efficient amount
So as a society, if we want to achieve efficient outcomes, we need to design the law to discourage this type of behavior.
How do we do this?

10. An example +  punish the choice Choice Bad Luck Outcome criminal law
regulations
With contract law, we wanted to create incentives for efficient behavior – efficient commitment to keeping your promises, efficient reliance on other peoples’ promises
And it was straightforward to do this, because if you breached a contract, or made a reliance investment, you intended to do that
Tort law is more complicated, because Gray didn’t kill three people on purpose
What he did was take an action – getting drunk, and then driving home – that increased the likelihood of having an accident
He could have killed someone while driving sober, too; it just wouldn’t have been as likely.
So he chose some action, and then in addition, ran into bad luck
(He could just as easily have made it home without incident, or sideswiped a fire hydrant.)
And a combination of his choice, and bad luck, led to a really bad outcome
So how do we create an incentive to avoid this type of outcome? We could do it in several different ways.
We could punish the choice he made. That is, we could make it illegal to drive drunk, whether or not you cause an accident. (And indeed, we do; although the punishment for drunk driving if you don’t kill someone is a lot less severe than the punishment if you do.)
Similarly, we have speed limits; we have safety regulations requiring retail stores to have working fire extinguishers, and restaurant kitchens to maintain a certain level of hygiene; and we can fine people for violating these regulations, even if there was no fire or nobody got food poisoning
Choice +
Bad Luck 
Outcome

11. An example +  punish the choice punish the outcome
criminal law
regulations
punish the outcome
“strict liability”
Or, we could punish the outcome. That is, we could say, if you kill someone with your car – regardless of whether you were drunk or sober, regardless of whether you were speeding or driving slowly – there will be consequences. (In tort law, these consequences are generally money damages.)
Suppose we say, if you kill someone with your car – regardless of the circumstances – you owe their family $1 million. Then (the theory goes) you internalize the externality your drunk driving would have caused – you say, “I’d better not drive drunk, because if I do, I’m more likely to hit someone and owe their family a lot of money.”
Or, we could punish the combination of the choice and the outcome. That is, we could say, “If you hit someone with your car, then we’ll do a breathalyzer test, and if it turns out you were drunk, there will be consequences.” Similarly, after a fire in a store, we can check whether there was a fire extinguisher, and when someone gets food poisoning and sues a restaurant, we can inspect their kitchen. This is the logic behind a “negligence” rule in tort law.
This would also create an incentive to behave well – the logic would be, “if I’m going to drive, I’d better stay sober, so that if I hit someone, I won’t be liable.”
It turns out, our legal system has some aspects of all three of these.
(There are other possibilities too. We could make drunk driving technologically impossible, by putting breathilizer locks on all cars. We could make drunk driving even more dangerous, by having narrower, winding roads with unexpected impediments and cars that explode on impact, to make the private cost of driving drunk higher.)
Choice +
Bad Luck 
Outcome
punish the combination of choice and outcome
“negligence”

12. Tort law Tort, noun. from French word meaning injury
Contract law: situations where someone harms you by breaking a promise they had made
Tort law: situations where someone harms you without having made any promises
“If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.”
The area of law dealing with accidents is called tort law
The word tort is from French, and means injury
With contract law, we studied situations where someone injured you by breaking a promise they had made
With tort law, we will look at situations where someone harmed you without having made any promises.
A line I like from the Friedman book:
“If someone shoots you, you call a cop. If he runs his car into yours, you call a lawyer.”
In fact, the line between tort law and criminal law isn’t always clear
Some torts are crimes as well – if someone assaults you, they may go to jail, and you may also sue them for damages
(Plus, there’s the OJ Simpson case.)
We’ll get to criminal law in a few weeks; for now we’ll focus on torts – civil actions for harms done to another person.

13. As always, we’ll be focused on achieving efficiency
I hit you with my car, do $1,000 worth of damage
You’re $1,000 worse off
(No damage to me or my car)
Should I have to pay you damages?
I owe nothing
I owe $1,000
I owe $50,000
We see two things:
First, for efficiency, whatever happens after the accident is irrelevant – I’m better off paying nothing, you’re better off getting a big check, but no new value is created or destroyed either way
And second: that means this can’t possibly be the right way to think about efficiency for tort law
Your payoff
–1,000
49,000
My payoff
–1,000
–50,000
Combined payoffs
–1,000
–1,000
–1,000

14. distribution but not efficiency
Something to remember
distribution but not efficiency
Think back to the first day of class
Everything that happens after the accident – litigation, the eventual outcome, and how the law influences those – matters for distribution, but not for efficiency
What matters for efficiency is whether the accident happens – and therefore, all the actions and decisions leading up to the accident
So what we’ll be thinking about in tort law is the incentives that tort law creates, and therefore the actions it will lead to
If I expect to owe you $50,000 if I hit you with my car, maybe I won’t text while driving
If you expect not to be compensated for accidents, maybe you’ll bike more carefully, or less, or have a light on your bike when you’re riding at night
And so on
efficiency

15. Tort law
Question: how to structure the law to get people to behave in a way that leads to efficient outcomes?
Deliberate harms: make punishment severe (criminal law)
Accidental harms: trickier
Goal isn’t “no accidents”; goal is “efficient number of accidents”
So the question will be, how to to structure the law to provide incentives for people to behave in a way that leads to efficiency
For deliberate harms, this will usually be fairly simple
If we don’t want people to get in bar fights and break each others’ noses, we can just make the penalty for being in a bar fight very severe
This is roughly the intent of criminal law
We take a behavior we don’t want people to do, and assign a severe punishment for doing it
For accidental harms, though, setting the correct incentive to avoid harm is tricky
We could prevent all traffic accidents by outlawing cars
We could prevent all construction injuries by outlawing construction
We could prevent almost all traffic accidents by punishing fender-benders with death, and accept that this would lead to most people not driving, and those who did drive, driving 5 mph
But this would clearly be inefficient
What we want, instead, is the “efficient number of accidents”
That is, the number of accidents such that preventing another one would be inefficient (due to the resources it would require)

16. Tort law
Question: how to structure the law to get people to behave in a way that leads to efficient outcomes?
Deliberate harms: make punishment severe (criminal law)
Accidental harms: trickier
Goal isn’t “no accidents”; goal is “efficient number of accidents”
Unlike nuisance law, injunctive relief is not an option
Unlike contract law, no agreement ahead of time
Cooter and Ulen: essence of tort law is “the attempt to make injurers internalize the externalities they cause, in situations where transaction costs are too high to do this through property or contract rights”
Tort law differs from the other areas of law we’ve look at so far
Unlike in nuisance law, when it comes to torts, injunctive relief is usually not an option
Much as we’d like to imagine that nobody could run into your car without negotiating for permission, it doesn’t work that way
Unlike with contract law, there is no promise or agreement made ahead of time; something happens, and then we deal with it
Tort cases may involve parties who are complete strangers
We can think of tort law as covering the situations where transaction costs were too high to allow for bargaining
it’s impossible to negotiate with every driver for the right to hit you
it’s not always possible to bargain with an angry drunk about whether or not he breaks your nose.
Thus, Cooter and Ulen define the economic essence of tort law this way:
the attempt to make injurers internalize the externalities they cause, in situations where transaction costs are too high to do this through property or contract rights

17. Cast of characters Plaintiff – person who brings a lawsuit
Defendant – person who is being sued
In a nuisance case, the defendant caused a nuisance, plaintiff was bothered by it, might be asking for injunction or damages
In a contract case, defendant breached a contract or violated its terms
In a tort case, defendant caused some harm to plaintiff, plaintiff is asking for damages
Plaintiff is the victim (person who was harmed)
Defendant is the injurer (person who caused the harm)
We haven’t really said much about the legal process itself – who sues who and what happens then
We’ll come back to this a bit more at the end of the semester
But for now, we do need terms for who’s who

18. “Classic” legal theory of torts
Harm
Causation
Breach of Duty
With contract law, we started out by discussing a “classic” legal theory of contracts (the bargain theory), and then moved on to an economic analysis
With torts, we’ll do the same
The traditional theory of tort liability was developed about 100 years ago
It specified three key elements of a tort, which must be present for a plaintiff to recover damages:
harm
causation
breach of duty

19. Element 1: Harm
For a tort to exist, the plaintiff needs to have been harmed
“Without harm, there is no tort”
Gas company sold gas with a defective additive
Dangerous for cars with turbocharged carburetors
You have a car with normal carburetors
You might be angry; but you weren’t harmed, so you can’t sue
Similarly, no compensation for exposure to risk
Manufacturer exposed workers to some chemical
Exposure will cause 15% of them to develop cancer later in life
Can’t sue now – have to wait, see who gets cancer, then they can sue
First, and simplest, the plaintiff needs to have been harmed.
Without harm, there is no tort
An example from the textbook:
A gas company sold gas with a defective additive
It had no effect on cars with normal carburetors, but was dangerous in cars with turbocharged carbs
You have a car with a normal carburetor might be outraged by the situation
You might be outraged that you were sold a defective product; but since the gas did no damage to your car, you cannot sue
Similarly, traditional tort theory does not compensate for exposure to risk.
Suppose a manufacturer accidentally exposed a bunch of workers to some chemical
Doctors agree the exposure will cause 15% of them to develop liver cancer later in life
Under traditional tort doctrine, the victims must wait and see who gets cancer before suing
Similarly, if I do something negligent that causes you a 50% chance of dying, but you get lucky and escape the situation, I’m generally not liable for any damages.
(So far, U.S. courts have been reluctant to allow tort actions on the basis of exposure to harm, although some believe they should
Thus, safety regulation, administered by a government agency, is typically used instead of tort law to deal with exposure to low-probability harms.)

20. Element 1: Harm Perfect compensation
Money
In theory, harm has a simple economic interpretation: a downward shift in the victim’s utility
Like in the hairy hand case, we can imagine a victim has some utility function over health and money, with some sort of indifference curves
A car accident might lower my wealth
because my car is worth less
And also lower my health
because I got whiplash
So now I’m on a lower indifference curve
Perfect compensation should theoretically restore me to my original level of utility.
Money damages are typically how this is done.
Obviously, some amount of money can get me back to my original level of wealth
By repairing whatever broke on my car, or allowing me to buy a new car
If there is medical care available that would restore me to my original level of health, then the cost of this treatment would get me back to my original level of health as well, so I’d be back where I started.
Of course, there are some harms that can’t be undone
a lost leg, or some other permanent injury
But there may be some amount of money that would compensate for it, by getting me back to the same indifference curve I started out on
Just like in the hairy hand case, we can work out perfect damages in this way.
Health
Perfect compensation
restores victim to original level of well-being
generally done through money damages

21. Perfect Compensation Tangible harms Intangible harms Medical costs
Lost income
Damaged property
Emotional harm
Pain and suffering
Loss of companionship
In theory, perfect compensation should cover all losses
Historically, courts have been less willing to compensate for intangible or hard-to-measure losses
Over time, U.S. courts have started compensating for more intangible harms
Pro: the closer liability is to actual harm done, the better the incentive to avoid these harms
Con: disparity in award sizes, unpredictability
So that’s the theory – the notion of “perfect compensation”
In an accident, there may be certain clear, tangible losses: medical costs, lost income, property damage that resulted from an accident
These are usually straightforward to measure
And there may also be intangible losses, which are harder to measure: things like emotional harm, pain and suffering, loss of companionship due to someone’s death
In theory, perfect compensation is supposed to compensate you for all losses
But historically, courts have only been willing to compensate victims for tangible harms; courts have been less willing to compensate for intangible losses or losses that are difficult to measure
Over the years, however, American courts in particular have expanded the list of compensable harms to include many of these intangibles
One area where there is a huge disparity between tangible harm and actual harm is in the death of a child
If a drunk driver kills a child, there is no loss of income to the child’s family; if anything, they avoid the expense of raising the child.
This used to be a difficult problem for courts, as they could not find a tangible, measurable harm on which to base compensation.
Allowing compensation for emotional distress and loss of companionship solves this problem
There are pros and cons to trying to compensate for intangible harms
As we’ll see soon, the closer we come to setting liability equal to the actual harm done, the better we’ll set incentives for efficient harm avoidance
That is, we will want injurers to internalize the harm they do, so we want liability as close as possible to the actual harm
On the other hand, intangible harms are extremely difficult to calculate.
Reasonable people might disagree dramatically about the emotional harm of losing a leg, much less a child
(In addition, some people are horrified at the very idea of putting a dollar value on someone’s life
And clearly, there is no amount of money that would make most parents indifferent to losing a child)
So while compensation for intangible harms is an appealing idea, it leads to a great deal of disparity in awards, across different courts, or even within the same court, for similar injuries.

22. “Classic” legal theory of torts
Harm
Causation
Breach of Duty
We said the classic theory of torts has three elements: harm, causation, breach of duty
That covers the first element of a tort under the traditional view – harm
Next up: causation

23. Element 2: Causation
For a tort to exist, the defendant needs to have caused the harm to the plaintiff
Cause-in-fact
“But for the defendant’s actions, would the harm have occurred?”
The second element that must be present is causation – that is, the defendant needs to have caused the harm to the plaintiff
Here, things can get pretty tricky
Suppose the factory where I work exposes me to some chemical that increases my risk of some disease from 1% to 2%
Later, I come down with the disease
Did the chemical cause it?
The law distinguishes between two types of causes
The first is “cause-in-fact”
The test for cause-in-fact is generally the “but-for test”
That is, “but for the defendant’s actions, would the harm have occurred?”
There’s an example in the Friedman book that shows how tricky even this simple rule can be
Three friends go out hunting, one of them scares up a pheasant, the other two turn and shoot and both, mistakenly, at the same exact time, shoot the first one, one through the head, one through the heart.
Each one is very apologetic to the man’s widow, but says, “If I hadn’t shot him, he’d still be dead.”
Did either of them cause his death? But for either one’s actions, he’d still have died.
Another problem: the “but-for” test is that it doesn’t distinguish between recent actions and more distant actions.
I punch a guy in the face in a bar
Clearly, but for my punching him, his nose wouldn’t have been broken.
Also, but for him getting a job in Madison and moving here three years ago, he wouldn’t have been in my bar to get punched in the face, and the harm wouldn’t have occurred
So is his employer liable?
Also, but for his parents having conceived him, he wouldn’t have been alive to be punched in the face, and the harm wouldn’t have occurred
So are his parents liable?
(A friend’s Facebook status the other day was about a colleague’s wife who had hit a deer, wondering “who would pay for her pain and suffering, since the county should really keep deer fenced in”)

24. Element 2: Causation
For a tort to exist, the defendant needs to have caused the harm to the plaintiff
Cause-in-fact
“But for the defendant’s actions, would the harm have occurred?”
Proximate cause
Immediate cause – defendant’s action can’t be too distant from the harm
Palsgraf v Long Island Railway (NY Ct Appeals, 1928):
Guard pushed a passenger to help him onto train, passenger dropped fireworks he was carrying, they went off, explosion knocked down scales at the other end of the platform, which fell on Mrs. Palsgraf
Guard’s actions were not the proximate cause
For this reason, for a tort to exist, the defendant’s act must not only be the cause-in-fact of the harm, it must also be the proximate cause
Proximate just means close – that is, the immediate cause
There’s no clear definition for how close the cause must be.
There’s a famous case, Palsgraf v Long Island Railway (NY Ct Appeals, 1928), that addressed this problem:
Plaintiff [Mrs. Palsgraf] was standing on a platform of defendant’s railroad after buying a ticket to go to Rockaway Beach. A train stopped at the station, bound for another place. Two men ran forward to catch it.
One of the men reached the platform of the car without mishap, thought he train was already moving. The other man, carrying a package, jumped aboard the car, but seemed unsteady as if about to fall.
A guard on the car, who had held the door open, reached forward to help him in, and another guard on the platform pushed him from behind. In this act, the package was dislodged, and fell upon the rails.
It was a package of small size, about fifteen inches long, and was covered by a newspaper. In fact it contained fireworks, but there was nothing in its appearance to give notice of its contents. The fireworks when they fell exploded.
The shock of the explosion threw down some scales at the other end of the platform many feet away. The scales struck the plaintiff, causing injuries for which she sues.
The Long Island Railroad guard’s actions in pushing the passenger did indeed cause Mrs. Palsgraf’s injuries
he pushed a passenger who dropped a package of fireworks which went off and caused the scales to fall on her
But the court ruled his actions were too remote to be considered the proximate cause
As I said, though, there’s no precise legal definition for how close the action must be to the harm

25. Element 2: Causation
“A tree fell on a moving trolly, injuring passengers. One of them sued.
He succeeded in demonstrating that in order for the trolly to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip.
Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe.
If he had not driven over the speed limit, the trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.”
Court ruled driver’s negligence “had not caused the accident in the legally relevant sense”
Another example from the Friedman book:
I run into a friend on the street, and we stop to talk for a minute. We say goodbye, go our separate ways, and twenty seconds later, he’s crushed by a falling safe. Clearly, but for talking to me, he would still be alive – he would have passed that spot well before the safe fell. Did I cause his death? Am I liable?
Friedman claims this hypothetical is based on a real case:
“A tree fell on a moving trolly, injuring passengers. One of them sued. He succeeded in demonstrating that in order for the trolly to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip. Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe. If he had not driven over the speed limit, the trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.”
Thankfully, the court was not stupid, and the plaintiff lost
The court held that the driver’s negligence “had not caused the accident in the legally relevant sense.”
I’m not really sure what that means, but it seems pretty clear that innocent actions which led to an accident by chance, but did not increase its likelihood, should not be punished
In this case, the driver’s speeding was just as likely to prevent the accident (by passing that point before the tree fell) as to cause it
If we think about tort law as an attempt to set the right incentives, there is no reason to discourage the driver’s actions

26. “Classic” legal theory of torts
Harm
Causation
Breach of Duty
That covers harm and causation
The third element of a tort: breach of duty
Breach of duty is sometimes, but not always, necessary for a tort to exist

27. Element 3: Breach of Duty
(Sometimes required, sometimes not)
Element 3: Breach of Duty
Strict Liability
Negligence
Harm
Causation
Harm
Causation
Breach of duty (fault)
When someone breaches a duty he owes to the defendant, and this leads to the harm, the injurer is at fault, or negligent
Injurers owe victims the duty of due care
Negligence rule: I’m only liable if I failed to take the required standard of care – not if I was careful and the accident happened anyway
The third element is breach of duty, and is sometimes necessary and sometimes not.
There are two different rules we will consider for tort liability: strict liability and negligence
Under a strict liability rule, all that is necessary for liability is harm and causation
Under strict liability, if I hit you with my car, I owe you damages – whether or not I was driving fast or slow, drunk or sober, when I hit you
Under the common law, strict liability tends to be the rule for activities that are inherently dangerous
The book gives the example of a construction company blasting with dynamite – the company is liable for any harm caused by the blasting. Wikipedia offers the example of a tiger rehabilitation center – if a tiger escapes and causes injuries, the owner is responsible, no matter how careful he was
In most situations, however, there is a third element that must be demonstrated in addition to harm and causation.
It must be shown that the defendant breached a duty he owed to the defendant, and that this breach led to the harm
If I punch someone in a bar, I breach a duty not to punch them
When an injurer breaches a legal duty, he is “at fault,” or “negligent.”
A liability rule requiring all three elements – harm, causation, and fault – is referred to as a “negligence” rule.
Under a negligence rule, a defendant can argue that an accident occurred despite his best efforts to prevent it.
That is, under a negligence rule, even if I caused you harm, I’m not liable if I satisfied the appropriate standard of care and the accident happened anyway
For accidents, the “duty” owed to the victim is the duty of care
When that duty is breached, that is, when I am careless or negligent, then if I cause an accident, I am liable
When I meet that duty, even if you get hurt, I’m not liable

28. Hence the language in the trolly example
“A tree fell on a moving trolly, injuring passengers. One of them sued.
He succeeded in demonstrating that in order for the trolly to be where it was when the tree fell on it the driver had to have driven faster than the speed limit at some point during the trip.
Breaking the law is per se negligence, so the driver was legally negligent whether or not his driving was actually unsafe.
If he had not driven over the speed limit, the trolly would not have been under the tree when it fell, so, the plaintiff argued, the driver’s negligence caused the injury.”

29. So under a negligence rule…
If I breach my duty of due care and injure you, I am liable
If I exercise the appropriate level of care but still injure you, I’m not liable
How is the standard of care determined?
That is, how careful do I have to be to avoid liability, and who decides?
Is it negligent to drive 40 MPH on a particular road at a particular time of day? What about 41 MPH? 42?
Of course, this leaves the question of what is the appropriate standard of care, and who determines it – that is, how careful do I have to be to not be considered negligent?
In some cases, there may be a clear yes/no test – a swimming pool had a lifeguard on duty or it didn’t.
In many cases, there isn’t. Is driving a car 40 MPH on a particular road negligent? What about 41? 42?

30. How is the standard of care determined?
Some settings: government imposes safety regulations that are also used as standard for negligence
Speed limits for highway driving
Requirement that bicycles have brakes
Workplace regulations
Some standards are left vague
“Reckless driving” may depend on road, time of day, weather…
Common law focuses on duty of reasonable care
Level of care a reasonable person would have taken
(Civil law relies less on “reasonableness” tests, tries to spell out what level of care is required)
How is this standard of care determined in practice?
In some cases, the government imposes safety regulations that set the standard
speed limits for highway driving
the requirement that bicycles have brakes and cars have working horns
workplace regulations
and so on
Some standards are left vague
the definition of “reckless driving” may depend on the road, the time of day, the weather
in these situations, the common law tends to focus on the duty of reasonable care
like foreseeable reliance, this is the level of care that a reasonable person would have taken under the circumstances
If you took less care than a reasonable person would have, you are liable
If you took more care, you are not.
(The civil law tends to rely less on standards of “reasonableness”, and tries to be more specific in what duties are owed and what level of care is required.)

31. Strict liability versus negligence
Strict liability rule: plaintiff must prove harm and causation
Negligence rule: must prove harm, causation, and negligence
A little history
Early Europe: strict liability was usual rule
By early 1900s, negligence became usual rule
Second half of 1900s, strict liability became more common again, especially for manufacturer liability in American consumer products
U.S. manufacturers now held liable for harms caused by defective products, whether or not they were at fault
Under a rule of strict liability, proof of negligence is unnecessary; proving harm and causation is enough to establish liability
Under a rule of negligence, you must prove harm, causation, and negligence
Interestingly, the movement between these two rules has not always gone in the same direction.
Strict liability was the usual rule in much of Europe before the 1800s.
By the beginning of the 1900s, negligence became the usual rule
but in the second half of the 1900s, strict liability experienced a rebirth, especially for manufacturer liability in American consumer products.
Manufacturers in the U.S. are now held liable for harms caused by defective products, whether or not they were at fault – we’ll see examples of this shortly
The Friedman book spends a surprising amount of time on the problem of who should be responsible when a bottle of Coke explodes, which I guess used to be a pretty big problem before they switched away from glass bottles

32. “Classic” legal theory of torts
Harm
Causation
Breach of Duty
So that covers harm, causation, and breach of duty – the three elements of a tort under the classic theory
Next, we’ll begin our economic analysis of tort law

33. Economic model (might or might not get to this)

34. Precaution The more carefully I drive, the less likely I am to hit you
But, driving more carefully is also more costly to me
Must be some efficient level of care
Similarly…
Construction company can reduce accidents with better safety equipment, better training, working shorter days, all of which cost money
Manufacturer can reduce accidents by designing/inspecting products more carefully – again, more expensive
Let’s begin with an obvious statement:
The more carefully I drive, the less likely I am to hit you
But also, the more carefully I drive, the more inconvenient it might be for me
If I could only drive 10 mph, hunched over the steering wheel staring intently at the road, I’d be a lot less happy than I am now
Trading off the cost – in accidents I cause – against the benefits – getting places sooner – there must be some efficient level of care for me to take when driving
We mentioned before that injunctive relief doesn’t work for torts – I can’t negotiate ahead of time for the right to hit you
Similarly, transaction costs are typically too high for us to negotiate on how carefully I’ll drive
If it’s efficient for me to drive a little more carefully, then the benefit to you (and everyone) is greater than the cost to me
So if I were “allowed” to drive as recklessly as I wanted, there’d be some price you’d be willing to pay to have me drive more carefully
But the benefit is dispersed – a little bit goes to each pedestrian, not all to you
And enforcement would be expensive
So that doesn’t work

35. Actions by both injurer and victim impact number of accidents
speed like hell
drive slowly
drive drunk while texting
drive carefully
cheap, hasty manufacturing
careful quality control
save money
install smoke detectors, other safety equipment
bicycle at night wearing black
wear helmet and use light
Car hits a bicyclist – driver could be driving slow or fast, changing song on iPod or paying attention, could be drunk or sober, headlights working or not…
Bicyclist could be on bike path or in road, wearing reflective clothing or black, could be watching for cars or listening to music and oblivious
Textbook gives a bunch of other examples of things that either party could do to reduce the likelihood of different types of accidents
These are actually pretty boring, and that’s sort of the point – they’re not exotic, they’re just lots of obvious things that each party in an accident had some control over
LESS EFFORT TO PREVENT ACCIDENTS
GREATER EFFORT TO PREVENT ACCIDENTS
“LESS PRECAUTION”
“MORE PRECAUTION”

36. We will call all these things precaution
Precaution: anything either injurer or victim could do to reduce likelihood of an accident (or damage done)
The next two questions should be obvious…
How much precaution do we want?
What is efficient level of precaution?
How do we design the law to get it?
Clearly, some precautions are inefficient
Suppose there’s a radar system you could install in a car, which would beep if there’s a person in the road in front of you
And suppose we figured out that, if every car in the country had one of these, there would be, on average, 1 less accident a year
And the radar systems cost $10,000 each
Chances are, we would not want this
So the question is, for which precautions is the social benefit – the reduction in accidents – greater than the social cost – the actual cost of the precaution
And of course, is there a way to design the law so that the efficient level of precaution is naturally the level that gets taken
Wednesday, we’ll start to answer both those questions

37. To answer these questions, we’ll introduce a very simple model of accidents
Car hits a bicycle
In real life: driver probably has insurance
In real life: some damage to bicycle, some damage to driver’s car
In real life: driver and bicyclist may not even know what the law is
We’ll simplify things a lot, by assuming…
Only one party is harmed
Parties know the law, don’t have insurance (for now)
We’ll focus on one party’s precaution at a time
Any model, by definition, is an over-simplification of reality

38. Model of unilateral harm
x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident
Model of unilateral harm
Unilateral harm – just one victim
Precaution – costly actions that make accident less likely
Could be taken by either victim or injurer
We’ll focus on one at a time
Notation
x – the amount of precaution that is taken
w – the cost of each “unit” of precaution
so total cost of precaution is wx
p(x) – probability of an accident, given precaution x
p is decreasing in x
A – cost of accident (to victim)
so expected cost of accidents is p(x) A
suppose there is some type of accident that may or may not happen
I may run into you in my car
A manufacturer may accidentally use lead paint in its toys, etc
For simplicity, we will focus on the case of unilateral harm
that is, there is only one victim
both of us may contribute to the accident happening; but only one of us is directly made worse off by it
(not the case with car accidents where both parties get hurt)
There is also some amount of precaution that can be taken that makes the accident less likely.
This could be something the injurer does, or it could be something the victim does
We’ll consider either, but we’ll typically focus on one at a time
Let
x denote the level of precaution
we’re not going to worry about different types of precaution – we’ll just let x be the overall amount of care that someone is taking
w the cost of each incremental unit of precaution (could be money, time, inconvenience)
so total cost of precaution is w times x
p(x) the probability an accident occurs, given that level of precaution
so p(x) is decreasing in x, since more precaution = fewer accidents
A be the cost of an accident
borne by victim
so expected cost of accidents is p(x) A

39. Model of unilateral harm
x level of precaution w marginal cost of precaution p(x) probability of an accident A cost of an accident
Model of unilateral harm
efficient precaution: minx { wx + p(x) A }
w + p’(x) A = 0
w = – p’(x) A $
marginal social benefit of precaution
marginal social cost of precaution
wx + p(x) A (Total Social Cost)
Let’s graph some important quantities – with x (the level of precaution taken) on the x axis, and money on the y
We said the probability of an accident, p(x), is decreasing in the level of precaution
Since A is a constant, this means p(x) A – the expected cost of accidents – is downward-sloping
The cost of precaution is just a line, w times x
And we can add these together to calculate the total expected social cost related to accidents, wx + p(x) A
And now our goal in tort law becomes clear: to achieve the efficient level of precaution, which is the level of x that minimizes the total social cost
So we’ll put this in gold, and call it x*
(Of course, this assumes precaution is continuous – that you can take any amount you choose
Some precaution is discrete – you either turn on your headlights while you’re driving, or you don’t
But the conceptual goal is the same: to get headlight use when the reduction in accidents is greater than the cost
And to not get headlight use when the cost would be greater than the reduction in accidents)
wx (Cost of Precaution)
p(x) A (Cost of Accidents)
x* (Efficient Level of Precaution)
Precaution (x)
x < x*
x > x*

40. Model of unilateral harm
We haven’t yet said who is taking precaution
Some situations, only injurer can reduce accidents
Some situations, victim can too
Bilateral precaution – we’ll look at the two parties one at a time
Wednesday: consider effect of different liability rules on precaution
We haven’t yet specified who is taking this precaution
In many cases, it is mainly the injurer who can take precautions to reduce the likelihood of accidents
In some cases, the victim can also take precautions
We saw a bunch of examples from the textbook where both the injurer and the victim has some influence on the likelihood of an accident:
Faulty wiring causes house fire – manufacturer could make safer product, homeowner could fireproof their house
Car hits pedestrian – car could drive more carefully, pedestrian could cross in crosswalk and wear brightly-colored clothing
And so on

41. Effect of Liability Rules on Precaution (won’t get to this)

42. Effect of liability rules on precaution
Three rules we’ll consider:
No liability
Strict liability
Negligence

43. Rule 1: No Liability In a world with no liability…
Victim bears the cost of any accidents, plus the cost of any precaution he takes
Injurer bears cost of any precaution he takes, does not have to pay for accidents
First, we consider a world without lawsuits, where nobody is liable for any harms that they cause accidentally
In a world without liability, the victim gets no compensation, so he is stuck bearing the cost of any accidents that occur
Plus he bears the cost of any precaution he takes
The injurer, on the other hand, does not have to pay for accidents, so he only bears the cost of precautions he takes

44. Rule 1: No Liability Injurer precaution$
Private cost to injurer
wx + p(x) A wx
p(x) A x* x
Injurer’s private cost is just wx
Injurer minimizes private cost by setting x = 0

45. Rule 1: No Liability Victim precaution$
Private cost to victim
wx + p(x) A wx
p(x) A x* x
Victim’s private cost is wx + p(x) A
To minimize this, victim takes efficient level of precaution

46. Rule 1: No Liability So in a world with no liability…
Injurer takes inefficiently low level of precaution
(zero, or minimal amount)
Victim takes efficient amount of precaution

47. Rule 2: Strict Liability
Perfect compensation: damages D = A
Under strict liability…
Injurer pays damages for any accidents he causes
So injurer bears cost of accidents, plus his own precaution
Victim pays only for his precaution
Next, we consider Rule 2: Strict Liability
Suppose we are in a world with strict liability, where in the event of an accident, the injurer will have to pay damages D to the victim
And suppose that compensation is perfect – D = A, so the damages exactly compensate the victim for the harm.
Go back to the example of reflective clothing
Now the bicyclist knows that if he’s in an accident, he’ll incur harm of A and receive damages of D, so now the costs he faces are
w x + p(x) (A – D) = wx
So the cyclist minimizes this by setting x = 0
Under strict liability, the victim doesn’t bear the cost of accidents, so he has no reason to take any precaution
Is this efficient? No. The total social cost of accidents is
wx + p(x) A
the transfer of money from injurer to victim is just a transfer
So it would be efficient to set a higher level of precaution.
So a strict liability rule leads the victim to select an inefficiently low level of precaution.
But on the other hand, if it’s the injurer who affects the probability of accidents, strict liability ends up working pretty well
The injurer knows if there’s an accident, he’ll have to pay damages of D, so he minimizes
wx + p(x) D
and with D = A, this is
So he’s facing the same problem as minimizing the total social cost of accidents – so he chooses x efficiently!
(This is because, under strict liability, the victim is actually indifferent between accident and no accident – so the injurer’s actions cause no externality, so he chooses efficiently.)
So a strict liability rule leads the injurer to take efficient precaution.

48. Rule 2: Strict Liability Injurer precaution$
Private cost to injurer
wx + p(x) A wx
p(x) A x* x
Injurer’s private cost is wx + p(x) A
Injurer minimizes this by taking efficient level of precaution

49. Rule 2: Strict Liability Victim precaution$
Private cost to victim
wx + p(x) A wx
p(x) A x* x
Victim’s private cost is wx
No incentive to take any precaution, victim sets x = 0

50. Effect of liability rules on precaution
Victim precaution
Injurer precaution
No Liability
Efficient
Zero
Strict Liability
Zero
Efficient
Can also explain this via externalities
Injurer precaution reduces accidents
In a no-liability world, this creates a positive externality – the victim bears the cost of accidents, which is reduced by injurer precaution
Activities with positive externalities happen less than efficient amount, so we get less than efficient injurer precaution
Victim precaution does not cause an externality, since the victim is bearing the cost of accidents, and is therefore the only one who benefits when they are reduced
So victim precaution happens the efficient amount
In a strict liability world, the injurer bears the cost of accidents
Now injurer precaution does not create an externality – the injurer is the one who benefits from his own action, since he owes damages less often
So injurer precaution happens the efficient amount
But now victim precaution creates a positive externality – it’s good for the injurer, since it reduces the damages he’ll owe
Again, activities with positive externalities happen less than the efficient amount
So under strict liability, we get less than the efficient amount of victim precaution

51. So for accidents with unilateral precaution…
When it’s the injurer who can take precautions, a rule of strict liability is more efficient
When it’s the victim who can take precautions, a rule of no liability is more efficient
Each rule works well for one incentive, poorly for other
Similar to paradox of compensation we saw in contract law
Negligence rule may allow us to get both incentives right
Our results so far suggest that when only the victim is able to take precautions to prevent the accident, a rule of no liability is preferable
And when only the injurer is able to take precautions, a rule of strict liability is preferable.
(This is exactly analogous to the problem we saw in contract law, of allocating a risk to the lowest-cost avoider
When one party – in this case, victim or injurer – can take precautions and the other cannot, that first party is the low-cost avoider
Making them bear the cost of the accident leads to efficient unilateral precaution.)
With contracts, we saw that there was no breach remedy that set efficient incentives for both the promisor and the promisee – the paradox of compensation
Here, we find the same thing: a rule that sets the correct incentive for injurer precaution leads to too little victim precaution, and vice versa
So in settings with bilateral precaution – situations where both parties have the possibility of precaution – neither of these rules will lead to efficiency
(With bilateral precaution, things get a little more complicated – you’ll see an example of this on the homework.)
However, in tort law, there is a trick
We already defined a negligence rule, under which the injurer is liable for harm only if he did not take certain precautions
That is, in tort law, we can make damages depend not only on whether an accident occurred, but also on the level of precaution that the parties took ahead of time
This may allow us to get both incentives right.

52. Rule 3: Simple Negligence
“Simple Negligence” rule
Legal standard of care xn
Injurer is liable for damages if precaution level was below the legal standard of care
x < xn  D = A
x ³ xn  D = 0
So on our graph from before, private cost to injurer is…
wx + p(x) A for x < xn
wx for x ³ xn
Rule 3: Negligence Rule
Let’s think first about just injurer precaution
A negligence rule says that the injurer is liable for damages if his precaution level was below the legal standard of care, xn
So for x < xn, damages would be D = A
For x >= xn, damages would be D = 0
If we go back to the graphs we drew earlier, then, the total expected cost to the injurer (from both precaution and expected damages) will be
wx + p(x) A for x < xn, and just wx for x >= xn, since when x >= xn, the injurer is not liable for damages.
How this actually looks will depend on how xn, the legal standard for precaution, relates to x*, the efficient level of precaution
For now, let’s assume they’re equal, that is, xn = x*
(Our goal is to design an efficient legal system; so for now, let’s assume the court can set the efficient legal standard for negligence. We’ll see later what happens when it can’t.)

53. Rule 3: Simple Negligence Injurer precaution$
Private cost to injurer
wx + p(x) A wx
What will injurer do?
At x < x*, we know that wx + p(x)A is decreasing; and so the injurer’s expected costs are decreasing
Similarly, we know that wx is increasing, so above x*, the injurer’s expected costs, which are just wx, are increasing
So expected costs are minimized by setting x = x*, the efficient level.
So a negligence rule, with a legal standard of care x~ equal to the efficient level x*, leads to an efficient level of injurer precaution.
But now, what about the victim’s incentives?
The victim knows that under a negligence rule, the injurer will take precaution x*; and therefore, if an accident occurs, the injurer will not be liable
So now the victim is facing the full cost of any accident which occurs; which means that the victim also takes the efficient level of precaution.
So now we’ve found a solution to the paradox of compensation
A negligence rule, combined with an efficient legal standard for care, leads to efficient precaution by both injurer and victim.
Which is pretty cool.
(We’ll come back to what happens when standard for care is set incorrectly later.)
p(x) A
xn = x* x
Private cost is wx + p(x) A if x < xn, only wx otherwise
If standard of care is set efficiently (xn = x*), injurer minimizes private cost by taking efficient precaution

54. Rule 3: Simple Negligence Victim precaution
What about victim?
We just said, injurer will take efficient precaution
Which means injurer will not be liable
So victim bears costs of any accidents
(Victim bears residual risk)
So victim’s private cost is wx + p(x) A
Victim minimizes private cost by taking efficient level of precaution too! $
Private cost to victim
(assuming injurer takes efficient level of precaution and is therefore not liable for damages)
wx + p(x) A wx
p(x) A x*

55. Effect of liability rules on precaution
Victim precaution
Injurer precaution
No Liability
Efficient
Zero
Strict Liability
Zero
Efficient
Simple Negligence, with xn = x*
Efficient
Efficient