Economic Theories of Legal Liability

This essay synthesizes and re-conceptualizes some central results of the economic analysis of liability law and sketches the legal details that drive them. Three different legal mechanisms for creating efficient incentives are examined in turn. The first mechanism uses the legal rule of strict liability to internalize costs. The second mechanism uses a negligence standard to create and enforce efficient standards of behavior. The third mechanism uses law to channel transactions into voluntary exchange. The initial explanation of the three mechanisms makes simplifying assumptions of perfect information, solvency, costless dispute resolution, and risk neutrality, before examining the results of relaxing these assumptions. The rules of the three major bodies of liability law—property, contracts, and torts—will be analyzed as examples within these three mechanisms. Property law concerns appropriation of ownership rights or interference with them; contract law concerns broken promises; tort law concerns accidental or intentional harm to people or property.