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The Inefficiency of Contractually-Based Liability with Rational Consumers

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  • Abraham L. Wickelgren
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    Abstract

    The prevailing view in the law and economics literature is that preventing firms and consumers from contracting out of mandatory liability rules is optimal only if consumers are irrational or misperceive the risks of the products they buy. In this paper, I show that even if consumers do correctly judge a product's risk, if they cannot directly observe the safety characteristics of that product, then allowing firms and consumers to choose their own liability rules cannot lead firms to make efficient investments in product safety (unless the efficient level of investment is zero). Because the legal system is costly, consumers always have an incentive to waive liability in exchange for a lower price after safety investments are sunk. If they do so, however, firms will anticipate this, thereby undermining there incentive to invest in safety. Mandatory product liability provides a mechanism for consumers and firms to commit not waive liability. Copyright 2006, Oxford University Press.

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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Journal of Law, Economics, and Organization.

    Volume (Year): 22 (2006)
    Issue (Month): 1 (April)
    Pages: 168-183

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    Handle: RePEc:oup:jleorg:v:22:y:2006:i:1:p:168-183

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    Cited by:
    1. Calcott, Paul, 2008. "Liability and manufacturer warnings," International Review of Law and Economics, Elsevier, vol. 28(2), pages 98-105, June.
    2. Baumann, Florian & Friehe, Tim & Grechenig, Kristoffel, 2011. "A note on the optimality of (even more) incomplete strict liability," International Review of Law and Economics, Elsevier, vol. 31(2), pages 77-82, June.
    3. Florian Baumann & Tim Friehe & Kristoffel Grechenig, 2010. "Switching Consumers and Product Liability: On the Optimality of Incomplete Strict Liability," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2010_03, Max Planck Institute for Research on Collective Goods.

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