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Part D-II The Economics of Tort Law 11/10/09 Tort_B 1 1 Part D-II The Economics of Tort Law 11/10/09 Tort_B 1 1

Objectives n The economic model of Torts n Valuing risk - the cost of Objectives n The economic model of Torts n Valuing risk - the cost of harm n Valuing safety – the cost of precaution 11/10/09 Tort_B 1 2

An example Ms. Jones lives in South Windsor. It is 8: 00 in the An example Ms. Jones lives in South Windsor. It is 8: 00 in the morning and her first class at the U of W starts at 8: 30. She is late and knows that if she does not get to campus by at least 8: 15 all the nearby free street parking will be taken and she will have to pay to park. The cheap lots fill up first, so that the later she is the more she pays. Along the route from Ms. Jones’ home to campus there are school children on their way to school. If Ms. Jones travels at 30 kph, the probability that she will hit a child is 0. 0002. The faster she drives the greater the probability that she will have an accident. A typical accident costs $50, 000. 11/10/09 Tort_B 1 3

Ms. Jones' Choices Driving speed - kph 80 70 60 50 40 30 … Ms. Jones' Choices Driving speed - kph 80 70 60 50 40 30 … 5 11/10/09 Cost of precaution -parking costs (wx) $ 0 $ 5 $10 $15 $20 $25 … $40 What will she do? Drive 80 kph? Drive 30 kph? Note: every additional 10 kph of precaution costs her $5 x = amount of precaution w = cost per unit of precaution - $5 Tort_B 1 4

Risk faced by the children Speed kph Prob. of an accident P(x) Cost of Risk faced by the children Speed kph Prob. of an accident P(x) Cost of an accident A (Expected) Cost of harm P(x)A 80 70 60 50 40 30 … 5 Stay home 0. 0010 0. 0006 0. 0004 0. 0003 0. 0002 5 0. 0002 … 0. 000001 0. 0 $50, 000 $50, 000 … $50, 000 $50. 00 $30. 00 $20. 00 $15. 00 $12. 50 $10. 00 … $ 0. 05 $ 0. 00 What would the children want? Ms. Jones should stay home! 11/10/09 Tort_B 1 5

Problem: Ms. Jones wants to save parking fees and this requires her to drive Problem: Ms. Jones wants to save parking fees and this requires her to drive fast – take less precaution – impose more risk on the children. The children (and their parents) want to get to school safely – they don’t want to face the risk of being hit be a car. Why don’t the school children (their parents) pay Ms. Jones to drive more slowly – maybe help her with the higher parking fees? 11/10/09 Tort_B 1 6

If Ms. Jones drives 50 kph instead of 80 kph, then the children’s expected If Ms. Jones drives 50 kph instead of 80 kph, then the children’s expected harm falls by $35 (from $50 to $15) but her costs of parking only goes up by $15 (from $0 to $15). There is $20 in co-operative surplus to gain, if Ms. Jones and the children can agree on a reduced speed. Why not? Clearly a Pareto improvement is possible? Pay Ms. Jones $15 for her parking fee if she agrees to drive 50 kph and the children get a reduction in risk valued at $35. What a deal! 11/10/09 Tort_B 1 7

Why don’t such trades occur? Are they illegal? (no) If one of the parents Why don’t such trades occur? Are they illegal? (no) If one of the parents wanted to buy Ms. Jones’ car they would certainly be willing to try and do so! PROBLEM: if they try to buy less risk the transaction costs are far too high relative to the gain from each individual trade! All of the 100, or so school children would need to come together to negotiate with all of the drivers along the route each day. They would need to settle on fees to be paid to each driver to drive more safely, and the children would need to decide who pays what share of the fees. It is clear why this does not happen. Such trades do not take place because of the transaction costs outweigh the possible gains from trade. 11/10/09 Tort_B 1 8

This is what TORT LAW is all about. Trying to get Ms. Jones to This is what TORT LAW is all about. Trying to get Ms. Jones to drive more safely (but not too safely). There is a market failure in that the Pareto Improving trade cannot takes place because of the relatively high transaction costs (no cooperative bargain is possible). In property law and contract law we see that the law is necessary only when voluntary exchange fails due to high transaction costs (the exception). In the case of torts, the law is inherently necessary since high transaction costs which preclude voluntary exchange is the general case. 11/10/09 Tort_B 1 9

We want Ms. Jones to drive more slowly if the gain resulting from the We want Ms. Jones to drive more slowly if the gain resulting from the decreased risk to the children is greater than the increased parking she must pay (Potential Pareto Improvement or Kaldor-Hicks). We definitely do not want her to stay at home. And we likely don’t want her to drive at 5 kph. What precisely do we (society) want her to do? 11/10/09 Tort_B 1 10

Recall our previous example What does society actually want Ms. Jones to do? Cost Recall our previous example What does society actually want Ms. Jones to do? Cost of Precaution Speed (parking kph fee) Expected cost of harm 11/10/09 Cost of an accident wx 80 70 60 50 40 30 … 5 Stay at Prob. of an accident p(x) A p(x)A $ 0 $ 5 $10 $15 $20 $25 … $40 home 0. 0010 0. 0006 0. 0004 0. 0003 0. 00025 0. 0002 … 0. 000001 0. 0 $50, 000 $50, 000 … $50, 000 $50. 00 $30. 00 $20. 00 $15. 00 $12. 50 $10. 00 … $ 0. 05 $ 0 Tort_B 1 11

For each 10 kph in decreased speed Ms. Jones must pay $5 in additional For each 10 kph in decreased speed Ms. Jones must pay $5 in additional parking fees. Starting at very high speeds, as Ms. Jones decreases her speed the decrease in the expected cost of harm falls from $50 to $30 ($20) then from $30 to $20 ($10), then from $20 to $15 ($5), then from $15 to $12. 50 ($2. 50) Eventually the increase in cost to Ms. Jones becomes greater than the decrease in the value of the decreased cost of harm to the children (to much precaution). 11/10/09 Tort_B 1 12

What does society want? Another view Society wants to minimize the total cost of What does society want? Another view Society wants to minimize the total cost of accidents = cost of precaution + expected cost of harm Cost of Precaution Speed 80 70 60 50 40 30 … 10 11/10/09 Expected cost of harm Social cost of accidents wx p(x)A wx + p(x)A $ 0 $ 5 $10 $15 $20 $25 … $35 $50. 00 $30. 00 $22. 50 $15. 00 $12. 50 $11. 50 … $ 9. 50 $50. 00 $35. 00 $32. 50 $30. 00 $32. 50 $36. 00 … $44. 50 Tort_B 1 Minimum 13

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An exercise In the previous Ms. Jones example do the following (one at a An exercise In the previous Ms. Jones example do the following (one at a time) - - Increase and decrease the parking fee by 25% Increase and decrease the probability of an accident ( p(x)) 25% Increase and decrease the cost of an accident (A) by 50% In each case determine the optimal level of precaution. Draw the picture and show the various curves have changed relative to the original diagram. If there are 1, 000 cars driving the same route each day, how many accidents would you expect each year at the social optimum? 11/10/09 Tort_B 1 15