Question

2. Consider a driver who affects the expected cost of an accident by the speed at which he drives: The faster the driver drives the more likely an accident, although the driver enjoys being able to get to his destination more quickly. At the same time, a pedestrian can affect the expected cost of an accident by either reading his book as he walks down the street (BOOK) or not reading (NOBOOK). Assume that the pedestrian values reading his book by $10. The table below summarizes the choices available to each the driver and the pedestrian and the expected cost and benefit of each. Driver Benefit Pedestrian Benefits - Costs Expected Cost to Pedestrian BOOK BENEFITS Pedestrian Behavior BOOK NOBOOK Drive Rapidly 250 Drive Moderately BOOK NOBOOK Drive Slowly 160 BOOK NOBOOK a. What is the efficient behavior for both pedestrian and driver here and why? b. Analyze the driver's and pedestrian's behavior under strict liability, negligence and strict liability with a defense of contributory negligence. Does each rule lead to efficient behavior? c. If the driver is risk averse and the pedestrian risk neutral, what liability rule leads to efficient risk sharing and why?

Answer 1

Solution

a.The efficient behaviour for both pedestrian and driver is the case in which the benefits minus cost is the highest.

So,the situation is : Driver driving moderately.The pedestrian NOT READING THE BOOK

b.Strict liability : Under this criteria,the liability should be paid by the driver if anything happens to the pedestrians even though there are at no fault.So drivers should choose the case where there is the least amount of expected cost to pedestrians.

Driver should drive slowly.

Pedestrians can read the book because anyways the expected cost will borne by the driver in case of an accident.

Negligence :

Pedestrains should not read book because in that case the cause of accident from their end reduces.

Drivers should drive slowly.Pedestrian SHOULD NOT READ THE BOOK

Strict liability with a defence of contributory negligence

Driver should drive slowly.Pedestrian SHOULD NOT READ THE BOOK

c.Since the driver is risk averse then he/she will have to drive slowly because the faster they drive the more likely they tend to lead to accident.

But the pedestrian is risk neutral

This implies the liability rule applicable is : Strict liability so that the driver will be careful as the pedestrians are not caring about their risk (due reading their book)

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