Law and Econ Second half 😵

Tort Law

law that defines and enforces duties and rights among private individuals that are not based on contractual agreements

Why is Tort Law important?

It internalizes externalities. For instance, a careless driver imposes accident risks on everyone else but ignores these social costs. With tort liability, the driver is forced to internalize these costs. The driver now bears the true social consequences of behavior, thus changing their incentives.

Learned hand rule

B

Traditional Theory of Torts

- Harm (some form of reduction in utility/welfare)

- Cause (defendant must have somehow caused the harm)

- Breach of duty (risky behavior)

Perfect Compensation

the victim should be equally well off before and after compensation. Not necessarily literally restored physically, but some kind of money substitute for welfare loss.

In real life can be hard to assess.

However, economic theory favors perfect compensation because it fully internalizes social costs.

Cause-in-fact

"but for causation"; but for defendant's act, the injury wouldn't have occurred

Proximate Cause

The boundary of liability. Was the resulting harm a foreseeable, natural consequence of the defendant's conduct, or was the chain of events too remote? It is all about how foreseeable the harm was. Courts do not impose liability for infinitely remote consequences.

Why is Causation Economically important?

It sets a limit for how much people should reasonably invest in precaution. Causation doctrine helps define the proper scope of incentives.

Three Hunters Example

- Three hunters walk in a line

- The middle hunter flushes a pheasant

- The hunters on both sides turn and fire simultaneously

- The middle hunter is blinded by birdshot

We KNOW: one of the hunters causes the injury

BUT: it is impossible to determine which one

SO: causation is uncertain

PROBLEM: tort law requires causation for the defendant to recover damages

IF courts are rigid with proof: both hunters may escape liability even though one definitely caused blindness. This sets up a dangerous precedent

SOLUTION: shifting the burden of proof onto the plaintiffs, if they can't prove they did not cause harm, they may be jointly liable

ISSUE: what if hunter B definitely missed but doesn't have proof? Law and econ prioritizes incentive structures and minimizing social costs over moral reasoning

Negligence as an incentive system

Negligence law creates a legal standard of care. Thus, if actors meet the standard, they have no liability, while if they fall below, they are liable. This encourages rational actors to invest in precaution until reaching the legal standard. Thus the legal standard equals socially optimal precaution.

Negligence rule

Injurer is only liable if negligent. Thus, injurers must meet due care, and victims still have the incentive to protect themselves because if they act carelessly, they may not recover. It encourages bilateral precaution. Negligence mainly affects level of care, not activity frequency.

Strict Liability

Injurer pays regardless of care. Injurer must internalize all accident costs. Thus, is a form of unilateral precaution because the victim doesn't have to take precautions. It is preferred in situations where victims cannot realistically reduce risk like defective industrial products. Strict liability affects activity levels.

Contributory Negligence

A rule in tort law, used in only a few states, that completely bars the plaintiff from recovering any damages if the damage suffered is partly the plaintiff's own fault. It encourages victim precaution.

Comparative Negligence

A rule in tort law, used in the majority of states, that reduces the plaintiff's recovery in proportion to the plaintiff's degree of fault, rather than barring recovery completely.

Product Liability

the legal obligation of sellers to pay damages to individuals who are injured by defective or unsafe products because they possess superior information and control design.

Punitive Damages

Money damages that may be awarded to a plaintiff to punish the defendant and deter future similar conduct. This makes up for scenarios in which victims don't sue, harms are hard to detect, and firms profit despite occasional lawsuits.

Example: Only 1 in 10 people sue, formulaically, optimal damages need to be multiplied by 10 to preserve deterrence

Significance of Tort Law as a whole

Tort liability essentially puts a price on harmful behavior, thus incentivizing actors to pay for harms or behave more efficiently. It is extremely effective when transaction costs are too high and contracts cannot be enforced.

Assumptions of the original Tort model

1) Rational actors

2) No regulation

3) No insurance

4) Defendants always solvent

5) Zero litigation costs

Irrational decision-making

1) Underestimating ordinary low-probability risks: People act as if small risks=zero risk (texting and driving)

2) Overestimating Dramatic Risks: availability bias and media exposure (plane crashes)

Broader impact on Tort Law:

- incentives work when people accurately process risks

- irrationality causes people to ignore or overestimate risks, leading to inefficient precaution

Moral Luck

Negligence law evaluates ACTUAL conduct, not intended conduct

This can lead to liability being partially dependent on luck, not just morality (you're a safe driver but you get in an accident the one time you speed vs your friend is a reckless driver and never gets in an accident)

In this way, moral luck distorts incentives because actors may overinvest in avoiding tiny lapses and excessively take on costly precautions

So why not base liability on intent? Courts cannot reliably determine subjective intent (administrability>perfect moral accuracy)

Advantages of regulation

- possess technical expertise

- proactively prevent accidents

- address industry-wide risks

(Ex. FDA, OSHA)

Advantages of Tort Liability

- evaluates actual harms

- process individualized facts

- respond flexibly

- use decentralized enforcement

- Victims initiate claims in courts

When is Regulation Better?

- Technical Complexity (pharmaceuticals)

- Insolvent Firms (forces safety before accidents instead of bankruptcy)

- Diffuse small harms (Air pollution affects everyone but it would inefficient for everyone to sue)

When is Tort Liability Better?

- Courts may have better information (trials reveal individualized details)

- Regulators may be corrupt or captured (regulatory agencies can be bribed or lobbied by industry agents)

Insurance

Insurance separates risk-taking from financial consequences which creates a moral hazard as insured people take on less precautions because losses are shifted to insurers.

Insurance partially externalizes costs, kind of defeating the point of tort law and weakening incentives

However, it has benefits of spreading risk and promoting productive risk-taking

Subrogation helps with this because it allows the insurer to acquire the victim's right to sue

Insolvency and Judgment-proof problem

When the defendant cannot cover damages, capping expected liability to wealth. Results in dangerous actors underinvesting in safety.

Example: A company engages in catastrophic activity because bankruptcy limits liability exposure.

Can be solved with mandatory insurance, regulation, minimum capitalization, and criminal penalties

Litigation Costs

Lawsuits are expensive so victims won't sue if expected recovery is less than expected costs. This causes underdeterrence and plaintiffs "escape" liability

Connects to class actions, regulation, punitive damages

The Bargain Theory of Contracts

a promise is legally enforceable if it is given as part of a bargain. Bargains typically involve mutual exchange and reliance which indicates that both parties expected legal/economic consequences

3 Elements of a Bargain

- Offer (initiates potential cooperation)

- Acceptance (meeting of the minds, both parties should mutually understand)

- Consideration (something given to induce the promise, it creates seriousness, value, reciprocity)

The Peppercorn Theory

It is not generally the court's job to look into the adequacy of consideration if the parties are satisfied with the exchange. Transaction costs would explode if cords reviewed "fairness"

Example: "I'll give you $1 million for a peppercorn"

Expectation Damages

- put victim where they would have been if contract performed

- protect the expected value of cooperation

- What would plaintiff have gained if contract were performed?

Example:

Buyer contracts at low price, seller breaches, buyer forced to buy expensive substitute

Expectation damages = difference between contract price and replacement price

Reliance Damages

- Put a victim where they would have been without contract

- What losses did plaintiff suffer by relying on contract?

Example:

Business buys materials expecting performance, other party breaches, materials become worthless

Reliance damages compensate wasted investment

Restitution Damages

- Prevent defendant's unjust enrichment

- What benefit did defendant unfairly receive?

Example:

You pay money upfront for services, contractor breaches immediately

Restitution: They should return your money immediately because they should not unfairly benefit

The "Hairy Hand" Case (Hawkins v. McGee)

Doctor promises: 100% perfect hand

Operation fails and hand becomes worse

Expectation damages: compensate difference between promised perfect hand and actual result

Reliance Damages: compensate difference between original hand and worsened hand

Restitution Damages: compensate any sum paid to the doctor unfairly

Efficient Breach

Sometimes breaking a contract increased total wealth

This can be efficient if the seller still pays breach damages and continues to profit.

This goes against moral commitment but economics argues that forcing inefficient performance wastes resources

Purpose of Contract Law

Transactions costs would be extremely high if parties had to negotiate every contingency. Contract law supplies default rules, remedies, and interpretations.

It allows for planning, specialization, investment, trade, reliance, and economic growth while minimizing risk

Economic Preference for Expectation Damages

- preserve value of bargains

- induce efficient reliance

- support specialization

- facilitate planning

- encourage optimal exchange

*Perfect Expectation Damages: damages that leave the victim indifferent between performance and breach+compensation

Specific Performance and when it is efficient

- Court orders actual performance or fulfilling the original contract over monetary compensation

- efficient when substitutes are unavailable (rare art, land, assets)

Default Rules

- a legal rule that applies unless the parties contract around it

- Majoritarian Defaults: courts should choose the rule most parties would have wanted anyway, saves a lot of transaction costs

- Penalty Defaults: a rule most parties would NOT want, force parties to reveal private information, basically, if you want protection for unusual damages, YOU must speak up, markets function better with more information

Mitigation

- Victims of breach must: reasonably reduce losses and cannot intentionally let damages grow

- Mitigation helps prevent wasteful behavior

Liquidated Damages

An amount predetermined by the parties to a contract as the total compensation to an injured party should the other party breach the contract.

Courts often limit them because there is a difference between damages and punishment

(ex. If buyer breaches $100 contract, buyer owes $10 million. is a punishment, not a damage)

Courts don't just blindly force contracts because of coercion, overdeterrence, opportunism, and inefficient rigidity

Social Costs of Crime

- harms to victims

- prevention costs

- policing

- prison

- deterrence expenditures

- social fear

- enforcement costs

Retributivism

theory of punishment that emphasizes moral condemnation for crimes already committed

Punishment is justified based on morals

Economic/Utilitarian Theory of Crime

Punishment is only justified when it improves social welfare

Optimal Amount of Crime

marginal cost of additional enforcement equals marginal reduction in crime harms

Why? Because zero crime is too costly, socially and monetarily

Mens Rea (Criminal Intent)

The required guilty state of mind to hold a person responsible for a particular crime.

Crime continuum

0 -> Careful (Blameless) | Legal Standard of Precaution | -> Negligent -> Reckless (Fault) | Line Separating Civil Wrongs from Criminal Wrongs | -> Intentional -> Cruel (Guilt) -> 1

Why does intent matter Economically?

Intentional harm requires stronger deterrence because actors deliberately impose costs on others

Why is Crime a Public harm?

Crime affects:

- social order

- fear

- trust

- security

- public stability

This all justifies state involvement

*Even victimless crimes like gambling or drugs are justified as public harms because they create broader social costs

Criminal Attempts

Crime law is unique because attempts are still punishable even if harm fails. This is because attempts still create fear, risk, and public dangers.

Example: Murder intent is still punishable if the victim lives

Standard of Proof

Civil: preponderance of evidence (It requires the party with the burden of proof to convince the judge or jury that their claim is "more likely true than not true," meaning there is a greater than 50% chance that the fact is as they allege)

Criminal: beyond reasonable doubt (requiring the prosecution in a criminal case to prove a defendant's guilt to such a high degree of certainty that no logical or rational person could conclude otherwise)

Economic costs of false criminal convictions

- punishing innocent people

- undermining trust

- reducing legitimacy

- deterring lawful behavior

Types of Errors

Type I: Convict innocent person

Type II: Acquit guilty person

Criminal law heavily discourages type I errors

Expected Punishment Formula

Expected Punishment = probability of punishment x severity of punishment

Thus deterrence can be increased by harsher punishments OR greater certainty of punishment

Efficiency of Fines

- transfer wealth

- do not consume resources

- cheaper to administer

Results in society gaining money instead of paying prison costs

Limits:

- some criminals cannot pay

- gain large benefits from crime

- corruption

Marginal Deterrence

Punishments should increase gradually with seriousness

Example:

If armed robbery and murder carry the same punishment, robbers are incentivized to kill the witnesses

Crime as Rational Choice

Criminals are rational beings that compare expected gains vs expected punishment

This does not mean we should morally endorse criminals, it just means that criminal behavior, like other economic behavior is a systematic response to incentives

Responses to crime

- deterrence: punishment discourages future crime

- incapacitation: prison physically prevents crime by removing criminals from society

- rehabilitation: attempts to reform offenders

- retribution: criminals are punished because that is deserved

*Economic theory mostly focuses on deterrence and incapacitation

Timeline of crime in the US

1) 1930s-1960s: Crimes generally fell

2) 1960s-1980s: Massive crime increase (both violent and nonviolent)

3) 1990s: Large crime decline (the decline became one of the biggest criminological debates ever)

Imprisonment rates

The US massively increased incarceration from the 1970s onwards. US incarceration rates became extraordinarily high compared to Europe and Japan.

Demographics of Crime

Young men aged 15-25 commit the most crime

This means that changes in age distribution affect crime rates

(Baby boom generation reaching adolescence contributed to crime increases)

Demographics matter, but do not fully explain crime waves

Crime and Poverty

Assumption: poverty directly causes crime

Economic Findings: Relationship exists, but is weaker and complication:

- crime rose during prosperous 1960s

- crime fell during unequal 1990s

- recession did not always produce crime spikes

*Crime depends on incentives, not just poverty

Probability vs Severity of punishment

Traditionally, the US has often increased the severity of punishment more than the certainty. This means longer prison sentences, more policing, high arrest probabilities

However, economic theory suggests that criminals care about expected punishment and since people heavily discount unlikely punishments, certainty may matter more

Types of Deterrence

1) General deterrence: punishment discourages broader population from offending

2) Specific deterrence: punishment discourages same offender from reoffending

3) Incapacitation: Prison physically prevents crimes during incarceration