Law and economic models of tort

ECON 303: Law and Economics
Assignment 2: SC 2009

Due: Friday October 9th; Econ Department Office, level 6, OGG

Each question is worth 20 marks.

1. Beetle loves listening to music on his IPOD. He walks along the street, plugged in, and oblivious to what is happening around him. Beetle steps onto the road, doesn't hear an on-coming car, gets hit, and suffers multiple fractures. The driver of the car is shaken up a bit but suffers no injury and there is no damage to the car.
a. Describe the above scenario using an economic model of tort; and use this model to compare and contrast the efficiency characteristics of the following two rules: "proportionate liability" and "strict liability". [10 marks]
b. One of the hallmarks of New Zealand's Accident Compensation legislation is the removal of the right to sue for personal injury. Discuss the efficiency of common law as an institution for awarding damages associated with personal injury relative to parliament-made law (i.e. Accident Compensation Act). [10 marks]

2. Grey Collar (GC) is a skilled accountant working for ACE Ltd. GC's income is enhanced by omitting the bad and exaggerating the good in ACE Ltd's accounts. The payoff from this activity is given by X (measured in units of $10,000). The probability of GC getting caught by a forensic accountant and being convicted is 0.1. GC will be fined according to f(X) = 10 + X2 if convicted.
a. Assuming that GC is risk neutral, what is GC's optimal level of criminal activity? Illustrate your result in a suitably labelled diagram. [10 marks]
b. Every dollar that GC gets from fixing the accounts is a dollar loss to ACE Ltd. Now assume that ACE Ltd hires SPY, a forensic accountant, to check the company's accounting practices. GC is aware of this and knows that the probability being caught has now increased from 0.1 to 0.2. Will SPY's efforts change GC's criminal behaviour? If so, by how much? Should ACE hire the forensic accountant if her charge out rate is $10,000? Briefly discuss how your answer to (a) above would change if GC is risk averse.
[10 marks]