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Markets, Torts and Social Inefficiency

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  • Andrew F. Daughety

    ()
    (Department of Economics and Law School, Vanderbilt University)

  • Jennifer F. Reinganum

    ()
    (Department of Economics and Law School, Vanderbilt University)

Abstract

In this paper we examine the nexus between product markets and the legal system. We examine a model wherein oligopolists produce differentiated products that also have a safety attribute. Consumption of these products may lead to harm (to consumers and/or third parties), lawsuits, and compensation, either via settlement or trial. Firm-level costs reflect both R&D and production activities, as well as liability-related costs. Compensation is incomplete, both because of inefficiencies in the bargaining process and (possibly) because of statutorily-established limits on awards. We compare the market equilibrium safety effort and output levels to what a planner would choose. We consider two planners, one of whom is able to set safety standards, but takes the market equilibrium output as given, and one of whom can control both safety effort and output. We argue that the former type of planner is the better representative of what the tort system might do if faced with deciding upon a safety effort standard. We examine two measures of competitiveness: the number of firms, and the degree of substitutability of the products. Holding substitutability constant, an increase in the number of firms always reduces equilibrium safety effort. On the other hand, holding the number of firms constant, increasing substitutability first decreases, but ultimately increases, the equilibrium safety effort. Non-cooperative firms under-provide safety effort (relative to the restricted social planner¼s preferred level) when the products are relatively poor substitutes. However, when the products are sufficiently good substitutes, the non-cooperative firms over-provide safety effort. Moreover, the more firms there are in the industry, the less substitutable their products need to be in order for the equilibrium to result in over-provision of safety effort. Under-provision of safety becomes more typical as the rate of third-party exposure increases or as the amount of third-party uncompensated losses increases. Finally, we use the settlement subgame to examine the effects of alternative tort reform policies on the equilibrium provision of safety and welfare. In the presence of third-party victims, welfare can be increased even though changes in such policies may increase expected trial costs.

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File URL: http://www.accessecon.com/pubs/VUECON/vu03-w08.pdf
File Function: First version, 2003
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Bibliographic Info

Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0308.

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Date of creation: Apr 2003
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Handle: RePEc:van:wpaper:0308

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Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

Related research

Keywords: Liability; oligopoly; safety; social optimality; torts;

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References

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  1. Steven Shavell, 2003. "Economic Analysis of Accident Law," NBER Working Papers 9694, National Bureau of Economic Research, Inc.
  2. Marcel Boyer & Donatella Porrini, 2002. "Modeling the Choice Between Regulation and Liability in Terms of Social Welfare," CIRANO Working Papers 2002s-13, CIRANO.
  3. Daughety, Andrew & Reinganum, Jennifer, 1992. "Product Safety: Liability, R & D and Signaling," Working Papers 94-17, University of Iowa, Department of Economics, revised 1994.
  4. Lucian Arye Bebchuk, 1984. "Litigation and Settlement under Imperfect Information," RAND Journal of Economics, The RAND Corporation, vol. 15(3), pages 404-415, Autumn.
  5. Daniel F. Spulber, 1989. "Regulation and Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262192756, December.
  6. Jennifer F. Reinganum & Louise L. Wilde, 1986. "Settlement, Litigation, and the Allocation of Litigation Costs," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 557-566, Winter.
  7. A. Mitchell Polinsky & William P. Rogerson, 1983. "Products Liability, Consumer Misperceptions, and Market Power," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 581-589, Autumn.
  8. Hamada, Koichi, 1976. "Liability Rules and Income Distribution in Product Liability," American Economic Review, American Economic Association, vol. 66(1), pages 228-34, March.
  9. Kamien, Morton I & Muller, Eitan & Zang, Israel, 1992. "Research Joint Ventures and R&D Cartels," American Economic Review, American Economic Association, vol. 82(5), pages 1293-306, December.
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Citations

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Cited by:
  1. Andrew F. Daughety & Jennifer F. Reinganum, 2011. "Cumulative Harm and Resilient Liability Rules for Product Markets," Vanderbilt University Department of Economics Working Papers 1125, Vanderbilt University Department of Economics.
  2. Marcel Boyer & Donatella Porrini, 2010. "Optimal Liability Sharing and Court Errors: An Exploratory Analysis," CESifo Working Paper Series 3073, CESifo Group Munich.
  3. Marcel Boyer & Donatella Porrini, 2007. "Sharing Liability Between Banks and Firms: The Case of Industrial Safety Risk," CIRANO Working Papers 2007s-04, CIRANO.
  4. Marcel Boyer & Donatella Porrini, 2008. "The Efficient Liability Sharing Factor For Environmental Disasters: Lessons For Optimal Insurance Regulation," CIRANO Working Papers 2008s-03, CIRANO.
  5. Marcel Boyer & Donatella Porrini, 2010. "The Impact of Court Errors on Liability Sharing and Safety Regulation for Environmental/Industrial Accidents," CIRANO Working Papers 2010s-48, CIRANO.
  6. 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.

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