Product liability under ambiguity

Abstract

The introduction of new varieties of goods increases welfare under certainty and perfect competition. However, when the quality of new goods is uncertain, the need for a regulatory regime on liabilities and hazards arises. We examine the optimality of the regulatory mechanisms of quality under ambiguity (non-uniqueness of the probability distribution). We develop a model showing that product liability does not lead to optimality under ambiguity and so it constitutes an inadequate instrument for controlling the potential damages caused by innovative products. The level of precaution will be larger, equal or less than the optimal level and will decrease with the degree of optimism and will increase with the degree of pessimism. Consequently the price will not refect the actual product risk and consumers will buy either an insufcient or an excessive amount, according to the case. We present some considerations on the adequate institutional design, capturing the insights obtained in the comparison between regulatory regimes.