Ex ante Investment, Ex post Remedy, and Product Liability

Chen, Yongmin and Hua, Xinyu (2010): Ex ante Investment, Ex post Remedy, and Product Liability.

Abstract

Low-quality products may cause consumer harm. A firm can reduce the probability of low quality through ex ante investment before sales, and can take remedy actions such as product recalls if it learns after sales that product quality is low. An increase in the firm's product liability increases its incentive for ex post remedy; more ex post remedy, however, may reduce the firm's ex ante quality investment. On the other hand, higher product liability increases consumer demand for the product, resulting in high output and hence greater return to ex ante investment. The trade-off between these two effects, the "substitution effect" and the "output effect", can lead to an inverted U-shaped relationship between ex ante investment and product liability. We find that the firm always prefers full liability whereas consumers might be better off with less than full liability. Full product liability tends to be socially optimal when the potential consumer loss from low quality is sufficiently high; otherwise partial liability can be socially optimal.

• Item Type: MPRA Paper
• Language: English
• Keywords: Ex ante Investment, Product Recall, Product Liability
• Subjects: K - Law and Economics > K1 - Basic Areas of Law > K13 - Tort Law and Product Liability ; Forensic Economics; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality ; Standardization and Compatibility

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