Economics of Accidents and Learned Hand Formula of

Economics of Accidents and Learned Hand Formula of Liability for Negligence • Torts are wrongs that subject the wrongdoer to a suit for damages by the victim • Intentional and unintentional torts • Unintentional torts – injurer is liable under tort law to his victim in accidents • Expected accident cost = P * L • Ignore risk aversion, optimal precaution occurs when cost of taking precaution (=B) < expected benefit of taking precautions (= P * L) 1

• Optimal precaution will be achieved without legal intervention if person taking precaution is the same as person who may be injured • Otherwise legal intervention may be necessary • Legal intervention is not necessary if transactions costs are zero – Coase Theorem • If transactions costs are significant and legal system hold injurer liable for damages = L then his expected legal judgment cost = P * L 2

• Judge Learned Hand wrote that a potential injurer is negligent if but only if B < P * L; the formula for optimal accident avoidance • In the diagram, curve PL is the marginal change in expected accident costs as a function of care and curve B is marginal cost of care • To the left of c* the injurer is negligent • To the right of c* accidents are unavoidable in an economic sense. Why? 3

4

• Unusually large losses LO means no negligence is implied because B > P * L would normally hold unless LO >> L • Similarly if normally P is very low we will rule no negligence • Likewise if normally B is very high we will again rule no negligence • When applying the Hand formula average values are assumed by the court and negligence reflects individual variations from average values 5