Liability versus Regulation for Controlling Product-Related Risks

Liability and regulation are equally good at controlling product-related risks when consumers suffer the same expected harm and perceive risks correctly. When they misperceive risks, however, liability is preferred because the product price accurately signals risk and therefore induces efficient purchase decisions. When consumers vary in their susceptibility to harm and accurately perceive risk, regulation dominates liability because under regulation, consumers bear their own damages and are therefore induced to self-select in their purchase decisions. When consumers also misperceive risk, however, the choice between the two modes of risk control is ambiguous, with neither being capable of achieving the socially optimal outcome. Generally, regulation is preferred when consumers perceive risks fairly accurately, and liability is preferred when they do not. JEL Classification: K13, L51 Key words: Products liability, regulation, risk perceptions