CSIO working paper / Northwestern University, Center for the Study of Industrial Organization 0042
This paper investigates whether manufacturers should be liable if consumers, through the use of a product, cause harm to others. If consumers have deep pockets then consumeronly liability is socially desirable. With consumer insolvency, however, consumer-only liability leads to inadequate consumer precautions, inadequate safety features, and excessive economic activity. With homogeneous insolvent consumers, the best rule is "residual-manufacturer liability" where the consumer bears primary responsibility and the manufacturer bears the shortfall in damages. When consumers' willingness-to-pay is correlated with social harm they cause then residual-manufacturer liability distorts the market quantity. When consumers differ in their wealth then residual manufacturer liability creates an inefficient cross-subsidization and an overprovision of safety features. In both cases, consumer-only liability may be preferred to residual-manufacturer liability. Applications, including gun manufacturer liability, are discussed.