Product Safety: Liability Rules, Market Structure and Imperfect Information

In this paper we consider a durable good which fails randomly. Failure of the good results in a loss which consists of damages and possibly the destruction of the good itself. The safety characteristics are determined by the manufacturer, who takes account of the consumer's behavior. We determine the effects of market structure and liability rules on the chosen characteristics of the good. Clearly the safety characteristics of the good affect its cost of production and therefore the price paid by consumers. Thus our analysis of the desirability of alternative liability rules is based on the determination of their effects on consumer welfare. We show that product safety and consumer welfare depend on the terms of available insurance contracts. We also show that consumer's information plays a major role in determining the safety characteristics of the product and thereby consumer welfare. The desirable liability rule is shown to depend on the amount of information available to consumers.