Liability rules optimality

When both injurers and victims care and activity levels affect damages but the victims do not purchase products from the injurers, as in cases of damages to cyclists from automobiles, no liability rule is optimal (ShaveU 1987, 29). In contrast, if cyclists suffer damages as a result of defective bike manufacturing, strict UabUity induces bike prices to reflect aggregate damages. 

The inefficiencies creafed by sfrict liability will be small for those products whose consumers do not vary much in their care or activity levels, whose damages are not much affected by care or activity levels, whose damages are foreseeable by firms, and whose producers do not reorganize as a response to liability. Products with the opposite characteristics will cause large inefficiencies. So fhe optimality of liabilify rules is largely empirical and product specific rafher than theoretical. 

In the United States there are two sets of legal rules used in liability cases. In federal cases and most states the rule is that of comparative negligence. In Massachusetts, Virginia, North Carolina and the District of Columbia an older rule of negligence with a defense of contributory negligence is used. In economic theory, both rules will remove market failure and lead to optimal conduct by all parties (Shavell, 1987). 

If railroads are subject to strict liability to bystanders then the benchmark model would apply. This optimal result will not necessarily occur under a regime of negligence. Courts will define due care as consistent with the social>welfare maximizing level of preventive effort x). If the railroad provides this level of preventive effort or a higher level it will not be liable to compensate third parties. If it provides less preventive effort it will be liable. Therefore, the decision rule on the level of preventive effort is ... 

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