Liability Rules and Income Distribution in Product Liability
The Coase Theorem states that under certain ideal conditions resource allocation is unaffected by liability rules. This result, however, applies only in the absence of transaction or negotiation costs. Moreover, even though resource allocation remains unaffected, the income distribution between the parties is largely influenced by the liability rule. Take the celebrated example of a confectioner and a dentist. The final level of production activity after negotiation between the parties remains the same regardless of which party is liable. But the distribution of income between the confectioner and the dentist depends crucially on which party has the right to the environment. One of the characteristics of product liability is that producers and consumers are directly or indirectly associated through the price relationship. This very fact gives rise to a case where the conclusion of the Coase Theorem holds true even in the absence of explicit negotiations between the parties. Moreover, under certain conditions, the income distribution in terms of consumers' and producers' surplus could remain the same regardless of the liability rule. The purpose of this paper is to explore the implication of this price relationship on the product liability. In Section I, I shall analyze the case of product liability where the probability of damage is independent of the level of care taken by producers and consumers. It will be shown in a partial equilibrium framework that not onlv resource allocation but also income distribution in terms of consumers' and producers' surplus is unaffected by the liability rule, provided that consumers are fully informed of the intensity and the probability of the danger. In Section II, the assumption of the independence of the probability of damage from the care level is dropped. It will be shown that the game theoretic result obtained by John Brown' is still valid even if the quantity to be produced and consumed is a variable.
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