Logistics MT2 graded, will be returned today

Econ 522 Economics of Law Dan Quint Fall 2011 Lecture 19

Logistics MT2 graded, will be returned today
HW4 (last one) online – due Thurs Dec 8 Longer than last couple

Monday’s experiment

Experiment You have been asked to serve on a jury on a lawsuit dealing with personal injury. In the case before you, a 50-year-old construction worker was injured on the job due to the negligence of his employer. As a result, this man had his right leg amputated at the knee. Due to this disability, he cannot return to the construction trade and has few other skills with which he could pursue alternative employment. The negligence of the employer has been firmly established, and health insurance covered all of the related medical expenses. Therefore, your job is to determine how to compensate this worker for the loss of his livelihood and the reduction in his quality of life.

What were we trying to test?
Half of you were asked… The other half were asked… Should the plaintiff in this case be awarded more or less than $10,000? How much should the plaintiff receive? (Please give a number.) Are you male or female? Should the plaintiff in this case be awarded more or less than $10,000,000? How much should the plaintiff receive? (Please give a number.) Are you male or female? The question: how much did the “suggestion” affect answers to question (b)?

The results

The results Asked $10,000 Asked $10,000,000 Ratio Average 1,294,355
3,892,000 3.0 x Geometric Mean 382,653 2,086,764 5.5 x Smallest 50,000 140,000 25th Percentile 100,000 1,000,000 Median 250,000 1,600,000 4.6 x 75th Percentile 1,000,000 5,000,000 Largest 10,750,806 22,500,000 % at least $1 MM 36% 80%

The results

What does it mean? Nobody knows what a leg is worth
“Reference point bias” “Framing effects” On framing effects (from Huffington Post 1/28/2011): Radar Online reports that rapper Sean "Diddy" Combs was sued for $1 trillion by a woman named Valerie Joyce Wilson Turks, who alleges that he date raped her 24 years ago... and then conspired with Rodney King to bring down the World Trade Center on September 11th, 2001. In part, the suit alleges: "[Diddy] went through Kim Porter and Rodney King and knocked down the WTC and then they all came and knocked my children down... He date raped me 24 years ago and knocked me down him and Kim Porter and Wallace Wright, then Sean Combs and Kim and Wallace Wright came back 18 years later and raped and sexually abused my children and knocked my children down and crushed me and my children daily.“ Turks wants $900 billion for child support -- quite the expensive child -- and $100 billion in damages.

Back to work…

Punitive damages

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 Cooter and Ulen also go on for a while about the inconsistency of damages – across countries, and even across similar accidents within a country. As we saw last week, as long as damage awards are correct on average, random inconsistency won’t have much effect on precaution, under either a strict liability or a negligence rule. However, aside from fairness, there are probably other costs associated with this inconsistency Since the appropriate level of damages is not well-established, there is more incentive to spend more resources fighting for higher damages.

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” punitive damages What we’ve been talking about so far is compensatory damages – damages which are meant to “make the victim whole,” or to compensate for the damage actually done In addition to this, courts will sometimes award punitive damages – additional damages intended solely to punish the injurer, in order to create a stronger incentive to avoid the harm initially Most states have a rule for when punitive damages may be awarded Punitive damages are generally not awarded for innocent mistakes; as a general rule, they are considered when the injurer’s behavior is “malicious, oppressive, gross, willful and wanton, or fraudulent”

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 How punitive damages are calculated – both how they should be, and how they actually are – is even murkier than compensatory damages, and therefore subject to even more uncertainty and inconsistency They are supposed to bear a “reasonable relationship” to the level of compensatory damages, but “reasonable” has never been precisely quantified The U.S. Supreme Court has held that punitive damages more than 10 times compensatory damages will attract “close scrutiny” as possibly being too high, but doesn’t explicitly rule them out.

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… Many people have heard of the “coffee cup case”, Liebeck v McDonalds a 1994 case where a woman who was burned when she spilled a cup of McDonalds coffee in her lap she was awarded $160,000 in compensatory damages, and an additional $2.9 million in punitive damages. This is often held up as the “poster child” for excessive damages, although the actual facts of the case give a different picture.

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 degrees At 180 degrees, coffee can cause a third-degree burn requiring skin grafts in 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 Stella Liebeck bought coffee at a McDonalds drive-through, then parked to add cream and sugar When she took the lid off, she dumped the cup on her lap; the coffee soaked into her sweatpants and was held against her skin for 90 seconds, giving her third degree burns She was in the hospital for 8 days, and required skin grafts; after that, she had two years of treatment. She initially sued McDonalds for $20,000, mostly to cover $11,000 in medical costs They offered $800 She hired a lawyer, and sued for more McDonalds refused a number of offers to settle. At trial, it was revealed that McDonalds serves coffee at degrees. Liebeck’s lawyers presented evidence that at 180 degrees, coffee can cause a third-degree burn requiring skin grafts in seconds They claimed that lowering the temperature would increase the length of exposure required for severe burns, giving the victim time to deal with the spill. McDonalds, it turned out, had received 700 prior complaints of burns, and had settled with some of the victims. The quality control manager for McDonalds testified that the number of injuries (given how many cups of coffee McDonalds served) was not sufficient to cause McDonalds to reexamine its practices.

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 The jury used comparative negligence, and found McDonalds 80% responsible for the injury They calculated compensatory damages as $200,000, which they reduced to $160,000 And they added $2.9 million in punitive damages The judge reduced the punitive damages to three times compensatory damages, making the total award $640,000 during appeal, the parties settled out of court for some amount less than that. In this case, the jury seemed to be using punitive damages to punish McDonalds for being arrogant and uncaring. (The quality control guy from McDonalds was apparently a complete jerk on the stand.)

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 We’ve noted all along that when compensatory damages are perfect, incentives for precaution are set correctly. So what is the purpose of punitive damages? Cooter and Ulen give one economic justification They give the example of a manufacturer who can spend $9000 in quality control to eliminate 10 accidents a year, each causing $1000 worth of damage Clearly, this is efficient precaution, and therefore desirable. If every accident victim will bring a lawsuit and receive damages, the company has an incentive to spend the money However, if some of the victims will not – because they aren’t award of what caused the accident, or can’t prove it – then there is not a sufficient incentive to take precaution. Suppose half the victims will bring successful lawsuits. Compensatory damages in these cases would total $5000; the company is better off paying this than taking efficient precaution. One way to fix this is to increase damages when they are awarded We pointed out Tuesday that a rule which randomly threw out half the cases brought, and doubled the damages in the other ones, would give the same incentives for precaution Here, the logic is the same. Punitive damages can be added to compensatory damages to correct for the fact that not every victim will successfully sue; done right, this restores efficient incentives for precaution.

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 This suggests punitive damages should be related to compensatory damages, but higher the more likely the injurer is to “get away with it” If the probability of being successfully sued is 1/10, then total damages should be ten times the actual harm done, in order to create the right incentive; this requires punitive damages 9 times as great as compensatory damages. This sort of logic seems most appropriate when the injurer’s actions were deliberately fraudulent, since they may have been based on a cost-benefit analysis of the likelihood of getting caught Allowing punitive damages in these cases again causes the injurer to internalize the expected costs of his actions. Historically, punitive damages have always been paid to the victim, which seems arbitrary victim is already being made whole by compensatory damages creates a much greater incentive to sue – accidents become jackpots some states now have laws that a share of punitive damages goes to the state this creates its own set of issues, since the state now has a vested interest in victims being awarded punitive damages! In terms of setting the injurer’s incentives (or “punishing” him after the fact), it doesn’t matter where the money goes – setting it on fire would achieve those purposes But would obviously be inefficient…

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

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

U.S. tort system Punitive damages historically very rare
, 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

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

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 Cooter and Ulen cite a recent product liability survey of CEOs finding that “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.” The liability standard in many product-related accidents is “strict products liability”, which holds that a manufacturer is liable if the product is determined to have been defective. This can take three forms: a defect in design – as in cases where the design of a car’s gas tank made it liable to explode a defect in manufacture – a bolt is left off a lawn mower during assembly, or not tightened all the way; a piece flies off and injures a user a defect in warning – the manufacturer fails to warn consumers about the dangers the product poses One might expect precaution to be pretty unilateral – the manufacturer designs and builds the product – and so a strict liability rule might make sense However, there are elements of bilateral precaution People get injured turning their lawnmowers sideways to trip hedges. C&U suggest holding manufacturers strictly liable for defective design, manufacture, or warnings, but not liable when victims misuse the product or “voluntarily assume the risk of injury” (This is strict liability with a defense of contributory negligence) (Basically, holding the manufacturer liable in these cases means forcing them to provide insurance for their customers, which is probably inefficient.) They discuss attempts to reform product liability laws, in response to rising rates for liability insurance; some states put caps on damages. They give some unconvincing numbers, but point out that product-liability insurance costs are on the order of a quarter of a cent for each dollar of purchase price, which doesn’t seem all that problematic. As I mentioned the other day, if you’re interested, the paper by Schwartz spends some time looking at evidence of the effect of tort law – that is, how actual accident rates have responded to changes in liability rules – in a number of different industries.

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 Sabin 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 Recall a silly example from several lectures ago: I stop a friend to chat in the street, he later gets hit by a falling safe that wouldn’t have hit him if we hadn’t talked In a sense, I caused his death but I didn’t raise the ex-ante probability of it happening (I was as likely to cause him to miss the safe as to get hit by it), so I shouldn’t be held liable. Liability for vaccines is sort of an analogous situation Many vaccines for diseases are based on a weakened version of the disease itself, causing your body to develop a natural immunity to it. Thus, while they make you much less likely for you to acquire the disease, there is usually a very slim chance of contracting the disease directly from the vaccine. For example, the Sabin polio vaccine, which replaced the weaker Salk vaccine and basically wiped out polio, also causes 1 out of every 4,000,000 people who receive the vaccination to contract polio. A 1974 case established that the maker had to warn its consumers about this risk; since then, vaccines always come with warnings about the risks. Since then, however, a couple of people have been awarded damages after their children developed polio from the vaccine. If liability cannot be avoided through due care and warnings, it ends up built into the cost of the drug. Worse, it discourages companies from developing beneficial vaccines. The book gives a couple of examples – a 1976 outbreak of swine flu, and a more recent shortage of a vaccine against whooping cough – where a company refused to market a vaccine because it could not get liability insurance. In the first case, the government stepped in, basically ordering the company to produce the vaccine and assuming liability for itself.

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… Cooter and Ulen wrap up with a brief discussion of mass torts – situations where many people have been harmed in the same way, by the same plaintiff. Since the health risks of asbestos became widely known, over 600,000 people have come forward with lawsuits against 6000 different defendants Many of the claimants do not yet have, and may never get, an asbestos-related disease. Complicating things is that every state has a statute of limitations, a time by which actions must be started. One estimate is that asbestos litigation has already cost $50 billion, with less than half of that actually going to the victims; estimates are that future litigation will be even more costly. They don’t give much content about mass torts, other than to point out that courts have shown a willingness to use some creativity in handling the situations One example: the case of DES, a drug administered to pregnant women in the 1950s to prevent miscarriages, which was later found to lead to cervical cancer and other problems It was impossible to establish which firm had produced the dose that was given to a particular woman The California Supreme Court introduced the concept of “market share liability” – all manufacturers of DES were held liable for the harm, in proportion to their market share at the time. In this case, as in many others, victims did not all sue individually; large groups of plaintiffs were handled together. This is the idea of a class action lawsuit – a simultaneous lawsuit brought by lots of plaintiffs who were all harmed in the same way We’ll come back to this On the one hand, this gets around the problem of small, dispersed harms Remember our example from earlier: if a firm’s actions do $100 of damage to each of 10,000 people, it won’t be worth anyone’s time to sue But if someone can sue at once on behalf of all 10,000, the lawsuit will get brought, which means there is an incentive to take efficient precaution On the other hand…

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

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.”

The legal process

Over the last 2 ½ months, we have…
Developed theories of property/nuisance law, contract law, and tort law Looked at how rules of legal liability create incentives Thought about how these rules can be chosen to try to achieve efficient outcomes Over the last two months or so, we’ve developed theories of property and nuisance law, contract law, and tort law we’ve looked at how rules of legal liability create incentives and thought about how these rules can be chosen to achieve efficient, or close to efficient, results

Over the last 2 ½ months, we have…
To achieve efficiency, we’ve generally tried to set a party’s liability equal to the harm he caused someone else Damages in nuisance law Expectation damages in contract law Compensatory damages in tort law That way, he internalizes the externality he imposes, leading to efficient decisions In doing this, we’ve been making two big assumptions: The legal system works flawlessly The legal system costs nothing In general, in order to achieve efficiency, we’ve tried to set one party’s liability for damages equal to the harm he caused to the other party damages in nuisance law expectation damages in contract law compensatory damages in tort law That way, he would internalize the externality he was causing, and therefore make efficient decisions Implicitly, we were making two big assumptions: the legal system works flawlessly the legal system costs nothing The first assumption we made explicitly – by assuming we could set damages precisely in relationship to actual harm In tort law, we even examined the effect on incentives when it is violated The second assumption we made implicitly By ignoring the costs of the legal system in figuring efficiency And also by ignoring the private costs of litigation when considering the parties’ incentives. Over the next two lectures, we will relax these two assumptions, and explicitly consider the details of the legal system and the incentives it creates.

An example from Polinsky, “An Introduction to Law and Economics”
I hit you with my car and did $10,000 worth of damage We both know I was negligent But courts aren’t perfect If we go to trial, 80% chance I’ll be found liable, 20% I won’t If I’m held liable, damages are correctly set at $10,000 So on average, if we go to trial, you expect to recover $8,000 But if we go to trial, we both have to hire lawyers Suppose this costs us each $3,000 Now your expected gain from going to trial is $8,000 – 3,000 = 5,000 And my expected cost is $8, ,000 = 11,000 We begin with an example from a book by Mitch Polinsky, “An Introduction to Law and Economics” I hit you with my car and did $10,000 worth of damage. (Sorry.) You and I both know that I was negligent But we also both know that courts aren’t perfect If we go to trial, there’s an 80% chance I’ll be held liable, and a 20% chance I won’t If I am held liable, damages will be correctly set at $10,000 So if we go to trial, you expect to recover (on average) 80% X $10,000 = $8,000. However, if we go to trial, we’ll both have to hire lawyers, and lawyers are expensive Suppose going to trial will cost each of us $3,000 So now your expected net gain from going to trial is $8,000 – $3,000 = $5,000 Similarly, my expected cost if we go to trial is $8,000 + $3,000 = $11,000 Of course, since a trial will (in expectation) cost me $11,000 and earn you $5,000, it’s possible we can agree to settle without going to court. Any settlement between $5,000 and $11,000 makes both of us better off. So perhaps this will happen.

So… Going to trial gains you $5,000 (in expectation) Going to trial costs me $11,000 (in expectation) Maybe we can settle out of court If we avoid going to court and I pay you any settlement between $5,000 and $11,000, we’re both better off So maybe this happens But… So now your expected net gain from going to trial is $8,000 – $3,000 = $5,000 Similarly, my expected cost if we go to trial is $8,000 + $3,000 = $11,000 Of course, since a trial will (in expectation) cost me $11,000 and earn you $5,000, it’s possible we can agree to settle without going to court. Any settlement between $5,000 and $11,000 makes both of us better off. So perhaps this will happen. However, it’s also possible we disagree about the likely outcome of a trial You probably have some private information about the degree of your injuries I probably have some private information about how recklessly I was driving

Suppose I’m more pessimistic about my chances than you You think I’m 80% likely to be found liable I think I’m 90% likely to be found liable You think your expected gain is $8,000 – 3,000 = $5,000 I think my expected cost is $9, ,000 = $12,000 Now the range of possible settlements is even wider Any settlement between $5,000 and $12,000 is a Pareto-improvement over going to trial So settling is more likely First, suppose I’m more pessimistic about my chances at trial than you That is, you think I’m 80% likely to be found liable, but I think it’s more like 90% So you perceive your expected gain from trial to be $5,000 But I perceive my expected cost to be 90% X $10,000 + $3,000 = $12,000 This makes the range of possible settlements we’d both agree to even wider, and makes settling more likely.

Now instead, suppose I’m more optimistic about my chances than you You think I’m 80% likely to be found liable I think I’m only 10% likely to be found liable You think your expected gain is $8,000 – 3,000 = $5,000 I think my expected cost is $1, ,000 = $4,000 Now an out-of-court settlement is impossible There are no settlements that you and I would both agree to On the other hand, suppose I’m more optimistic about my chances You still think I’m 80% likely to be held liable, but I think it’s more like 10% Your expected gain from trial is still $5,000 But now my expected cost, given my beliefs, is 10% x $10,000 + $3,000 = $4,000 So now we’re very unlikely to settle.

And, even if our beliefs are compatible and there are settlements that we would both prefer to trial… …private information might lead to failure to reach a settlement Remember from before: if our threat points are private information, we might fail to reach an agreement because each of us is holding out for too big a share So even if we had the same beliefs about what will happen at trial, private information could prevent settlement Finally, even if our beliefs are compatible, that is, even if there is a range of settlements which would make us both better off than going to trial, the private information we both have might lead to a failure to settle. Recall from before, that if each of our threat points are private information, we might fail to reach an agreement because one of us tries to hold out for too big a share. So even if we both had the same beliefs about the likely outcome of a trial, private information could lead us to fail to settle.

So when litigation is costly… If the two parties agree on the likely outcome of a trial, there are gains from settling out of court, and a range of settlements they would both prefer to going to trial If the two parties are relatively pessimistic, settlement is even more likely If the two parties are relatively optimistic, settlement may be impossible Even if the two have the same beliefs or are relatively pessimistic, private information may lead to failures in bargaining This leads us to a few quick observations: When there are litigation costs, if we agree on the likely outcome of a trial, there will always be gains from settling out of court, and a range of settlements we would both prefer to trial If the two sides are relatively pessimistic – the injurer perceives his expected liability to be higher than the victim – settlement is even more likely If the two sides are relatively optimistic – the injurer perceives his expected liability to be lower than the victim – settlement may be impossible Even if the two sides have the same beliefs or are relatively pessimistic, private information may lead to failures in bargaining

So what? Under strict liability… But also…
We said injurers internalize cost of accidents  efficient precaution But this assumes cost of being sued = damage done If courts are unpredictable and litigation is costly, private cost of being sued for damages could be > or < cost of accident Which could lead to too much or too little precaution But also… If settlement talks break down and cases go to trial… …then total social cost of an accident includes the harm done, and the resources expended during the trial! If trial costs $6,000, then social cost of the accident isn’t $10,000, but $16,000 – which increases the efficient level of precaution! Recall that under a strict liability rule, the injurer bore the cost of accidents, and therefore internalized these costs and took efficient precaution But this assumed the cost of being sued was equal to the damage done With unpredictable courts and litigation costs, the private cost of being sued for damages can be either greater or less than the actual cost of the accident So this could lead to either too much or too little precaution. But it’s trickier than that as well Suppose we believe that settlement talks are likely to break down, and most cases will end up going to trial Then the total social cost of an accident includes the resources expended during a trial That is, rather than $10,000, the cost of an accident might really be $16,000 – the harm done, plus the cost of a trial If accidents do more harm, this means more precaution is cost-justified – the optimal level of precaution is higher than before! We’ve already spent a lot of time looking at how incentives respond to the private cost of accidents, so we’ll put that question aside for now. However, in the next couple of lectures, we’ll go into greater detail about the legal process itself – how these costs are incurred, and the effects this has.

The legal process

The goal of the legal process
Tort law: efficiency meant minimizing the total social cost of accidents Actual cost of accidents Plus cost of actions taken to prevent them (precaution) Goal of the legal process: minimize its social costs Direct (administrative) costs Error costs But first, it will help to have in mind what the theoretical goal of the legal process should be. Recall that the economic essence of tort law was to minimize the total social cost of accidents counting both the cost of the accidents themselves, and the costly actions that were taken to prevent them Similarly, in economic terms, the goal of the legal process is to minimize its total social costs. These costs come in two varieties: direct (administrative) costs, and error costs.

Administrative costs and error costs
Hiring judges, building courthouse, paying jurors… More complex process  higher cost Error costs Any legal process is imperfect Errors are any judgments that differ from theoretically perfect ones An error in computing damages after the fact only affects distribution, not efficiency But anticipated errors affect incentives, which may lead to actions which aren’t efficient Error costs are costs of distortions in actions people take (precaution, activity levels, etc.) due to flaws in legal system Administrative costs are obvious. If a legal process is going to require judges, you have to hire judges. If it’s going to require courtrooms, you have to build a courthouse. If it’s going to require jurors, you’ll have to pay the jurors. The more complex the process is, the more it is likely to cost. Error costs are less obvious. Any legal process will be imperfect some defendants will not be found liable when they should be damages will sometimes be set incorrectly, and so on. We can think of an error as any judgment that differs from the theoretically perfect judgment That is, any result that is different the judgment a court would impose if it were infinitely wise and had perfect information An error in computing damages after the fact will affect distribution but not efficiency That is, after the fact, me paying you very high damages, or not being found liable when I should be, will matter to us But since the damage is already done, it won’t affect efficiency But anticipated errors also affect the costs that each side perceives as stemming from their actions And therefore change incentives, and may lead to actions which are not efficient. Error costs are the costs of any distortions in actions (precaution, activity levels, etc.) due to imperfect incentives caused by flaws in the legal system An example we already saw: if courts make errors in sometimes not finding injurers liable, this may lead to lower precaution, which is inefficient This inefficiency – however much the results differ from what would happen if damages were always set correctly – is an error cost

The goal of the legal process
So theoretically, the efficient legal process is the one that minimizes the sum of… The direct costs of administering the system, and The economic effects of errors due to that process not being perfect We can think of this in relation to a tradeoff we’ve already seen several times: the tradeoff between simpler and more complex rules. Think of fast fish/loose fish versus iron holds the whale, or first possession versus tied ownership. One rule is a “bright-line rule” – very straightforward and simple to apply, leading to fewer disputes and simpler trials. This should have lower administrative costs. The other rule, however, creates better incentives under certain situations – and thus has lower error costs.

Midterm Nice job! Similar distribution to first – mean 84, median 85
Again, not actually assigning letter grades till after final… …but roughly, is about the B range A-G H-M N-Z

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