Economics and Liability for Accidents

Legal liability for accidents determines the circumstances under which injurers must compensate injurers for harm. The effects of liability on incentives to reduce risk, on risk-bearing and insurance (both direct coverage for victims and liability coverage for injurers), and on administrative expenses are considered. Liability is also compared to other methods of controlling harmful activities, notably, to corrective taxation and regulation. * Samuel R. Rosenthal Professor of Law and Economics, Harvard Law School. I wish to thank the John M. Olin Center for Law, Economics and Business at Harvard Law School for research support. 1 Economics and Liability for Accidents © 2005. Steven Shavell. All rights reserved. Legal liability for accidents governs the circumstances under which parties who cause harm to others must compensate them. There are two basic rules of liability. Under strict liability, an injurer must always pay a victim for harm due to an accident that he causes. Under the negligence rule, an injurer must pay for harm caused only when he is found negligent, that is, only when his level of care was less than a standard of care chosen by the courts, often referred to as due care. (There are various versions of these rules that depend on victims’ care, as will be discussed) In fact, the negligence rule is the dominant form of liability; strict liability is reserved mainly for certain especially dangerous activities (such as the use of explosives). The amount that a liable injurer must pay a victim is known as damages. Our discussion of liability begins by examining how liability rules create incentives to reduce risk. The allocation of risk and insurance is next addressed, and following that, the factor of administrative costs. Then a number of topics are reviewed. Comprehensive economic treatments of accident liability are presented in Landes and Posner (1987) and Shavell (1987); an early, insightful informal, economically-oriented treatment of liability is presented in Calabresi (1970). Empirical literature is surveyed in Kessler and Rubinfeld (2006) and is not considered here.