Everybody Out of the Pool: Products Liability Punitive Damages and Competition

Posted: 20 Jan 1998

See all articles by Andrew F. Daughety

Andrew F. Daughety

Department of Economics, Vanderbilt University

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics

Date Written: November 1995

Abstract

In this paper we examine the interplay between punitive damages and competitive forces in generating equilibria which reveal the safety of a product. We first construct a model to study the monopoly provision of a product whose safety is unobservable to consumers prior to purchase but is known by the firm and can be signaled via the product's price. Consumers have a role in this model in that their likelihood of purchase is based on the price they observe thereby reducing the incentive for mimicry of the more-safe product by the less-safe one. Nevertheless absent punitive damages there is a broad (and socially significant) portion of the parameter space wherein no revealing equilibria exist. That is the less safe product is able to take advantage of (rationally formed) consumer is perceptions of product safety since pooling (i.e. both product types charging the same price) characterizes the equilibria of this region. Further we show that punitive damages can be used to induce revelation(the less safe product is induced to break the pool) and we characterize the minimal punitive damages necessary to do this. We then embed this model in a multiple-firm context and characterize how the extent of competition influences this aforementioned required level of punitive damages. We find that competition reduces the required level of punitive damages especially in the most socially significant cases (those wherein the difference between the relative levels of compensation is greatest with respect to the relative levels of losses incurred). Competition and punitive damages are complementary in the sense that they jointly make consumer choice more effective by creating conditions under which revealing equilibria can exist.

Suggested Citation

Daughety, Andrew F. and Reinganum, Jennifer F., Everybody Out of the Pool: Products Liability Punitive Damages and Competition (November 1995). Available at SSRN: https://ssrn.com/abstract=54412

Andrew F. Daughety (Contact Author)

Department of Economics, Vanderbilt University ( email )

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Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States
615-322-2937 (Phone)
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