A Series on Law and Economics: Part III
Economic Consequences of Making Errors and Hand Rule
James DongA Shin
Economic Effects of the Court’s Errors
In this part, we shall delve a little deeper into the analysis of tort law by looking at the economic consequences of the Court’s errors. When dealing with tort cases, the Court often makes mistakes regarding the amount of harm, hence damages to be paid by the injurer. Such mistakes directly impact the behavior of the injurer as he responses to differing extent of mistakes differently. Attached at the end of the article is an explanation of Hand Rule, a rule that comes in handy when the Court wants to determine the legal standard of care (x^) and whether the injurer was indeed negligent.
1. Strict Liability: Under strict liability discussion can be further divided into cases of random and systemic mistakes as the only variable that the Court could change is damages.
- Random mistakes (uncertainty): the Court could err high or low when determining damages d, but on average damages are assumed to be correct. Therefore, expected damages, Exp(d) is same as the h, the amount of harm. While d is random as we have designated it with Exp, the presence of random errors does not change the outcome because on average it is 100% of d. The injurer simply takes x* because doing so minimizes x Ci = Exp(pd)+x. Since the exact d is not known to the injurer, the equation basically becomes p Exp(d)+x=>ph+x=>x*. The injure would care only expected d. It doesn’t change anything, as the incentives are unchanged.
- Systematic mistakes (Errors): A situation when the Court sets the damages incorrectly on average, consistently too high or low. Strict liability causes the injurer precaution to respond in same direction as the Court makes the error. (If d turns out to be smaller than h, when the Court mistakes by ordering a under-compensation, the injurer would then minimize x Ci = pd + x. Originally d was h, but now that the Court is being lenient d=ah where 0<a<1, with 1 being very accurate and fair. Thus pah+x-> x<x*. Extremely and unfortunately when d is 0, there would no precaution for the injurer to do. This outcome is repeated when the authority (police, justice department, etc.) fails to hold injurers liable. Suppose the chance of not paying h (or phrased differently, not getting caught), the enforcement error a is 20%. Result would be the same as the case of the Court making systematic mistakes: x<x*.
2. Negligence: As the Court should determine not just the amount of damages but also care, discussion under negligence rule can be further divided into cases of making errors in setting damages and x^.
- Small errors (modest errors) in setting DAMAGES: there is no effect on x. Thus, x=x*. Injurer still minimizes its cost by taking x* precaution. So under negligence rule, whether the Court makes systematic or random mistakes in setting damages has no effects on injurer’s precaution. Still injurer takes x = x* so that he could get away from paying d. Compared with the outcome under strict liability above, negligence seems to have merit when the Court errs on determining the d, whether systematically or randomly.
Same outcome is found when the authority occasionally fails to hold injurers liable!
- Errors in setting X^: Unlike the case of the Court making errors in setting damages, injurer’s precaution responds exactly to the way the Court makes systematic errors in setting x^. Say d=h but x^ is not equal to x*, which is when the Court makes errors. Let’s first assume the Court is being moderate in terms of setting the standard/legal care, x^ = 0, a case of the Court being super lenient. Ci would then be just the standard precaution level (x=0), causing too many accidents and hence a high social costs. In the opposite of being very harsh Court (x^=2), the injurer would take x=2, which would be again inefficient.
So far has been the discussion when the Court is widely known to make mistakes in one direction or another. What happens if we have no idea as to the way the Court behaves? That is when the Court makes random errors in setting x^. The answer is that it leads to over-precaution on part of injurer, a socially inefficient outcome. Let’s say x1=2 with 10%, x*=3 with 80%, x2=4 with 10%. Thus, the average x^ would be 3. A natural consequence for the injurer is “I would rather be safe by taking x2 and get free from ever paying p(x)D!”
Hand Rule is a rule that helps determine the standard of care and injurer’s negligence. B (cost of precaution) < L (gravity of resulting injury) x P (probability of accident). Care should be taken if doing so is efficient: B< PL. (or W<Ph). Thus if you didn’t take it under such a situation, you’re found to be NEGLIGENT.
If the concept of marginality is considered, the equation might look a bit different while the essence is the same. If W, the marginal cost of precaution, is less than -p’(x)A = ∆Ph, injurer is held negligent.
FINAL TAKE AWAY
If the Court can assess damages better than care, strict liability is better.
If the Court can assess standard care better than damages, negligence is better.
If care is vague, the Court better errs on lenient side.
“Courage and perseverance have a magical talisman, before which difficulties disappear and obstacles vanish into air.” – John Q. Adams
James DongA Shin is a co-founder of JS & Associates and a Senior Partner at Yonsei ULS. Please be advised: the comment, writing, or column does not represent the official position of YULS