ABSTRACT
The standard economic analysis of liability rules mainly focuses on the direct accident costs. However, accidents often create other costs which are often as large as the direct accident costs and occasionally much higher. In this note, we present a simple model of the tertiary and third-party costs created by accidents. We show that the inclusion of these costs significantly changes the relative efficiency of fault liability compared to strict liability. We show that fault liability with an appropriately high level of due care yields higher social welfare than strict liability, even under variable activity levels. The welfare-maximizing and incentive-compatible due care level is higher than what Hand’s rule will suggest. Further, the superiority of fault liability over strict liability increases with the importance of uncompensated tertiary costs relative to direct accident costs. Thus, we provide a new case for the high standard-based fault liability vis-à-vis the strict liability.
Singh, Ram and Schaefer, Hans-Bernd, A new case for a higher standard of care: The uncompensated tertiary and third-party costs. Posted to SSRN 5 January 2026.
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