On the Optimal Structure of Liability Laws

We consider the control of two-party accidents through the use of liability rules that assign damages according to whether or not predetermined standards for care have been met. Particular emphasis is given to how the differential in the costs of accident avoidance activities affects the optimal legal rule and optimal care standards. It is shown that when the costs are close to uniform across individuals, an approximation to the first-best can be obtained. Moreover, alternative legal rules are equally efficient in achieving this situation. When the differential widens, legal rules will differ in their ability to reach the second-best. In contrast to previous models of liability law, it is shown that the courts must play an active adjudicatory role in the optimal solution.