Answer the following three (3) questions and upload a document containing your answers to Canvas. You must show all work.

1.   Consider the following hypothetical concerning the economics of products liability. Let  the inverse market demand for a product be given by the expression  = 5,000 − 20 ,   where P is the price and Q is the quantity demanded. The inverse market supply for this  product is given by the expression  = 1,000 + 5 and the market is competitive. When a consumer purchases one unit of this product, a harm of $10,000 arises with a                 probability of 0.1. Suppose initially that consumers and firms accurately perceive this      risk.

a.   What is the equilibrium price and quantity under no liability?

b.   What is the equilibrium price and quantity under strict liability? Assume that courts do not err when awarding compensatory damages.

c.   What is the equilibrium price and quantity under strict liability when courts award punitive damages of $50,000 in addition to compensatory damages of $10,000?

Assume now that courts err when awarding damages under strict liability. In particular, they only award a fraction s of harm as damages to the plaintiff, where  ∈ [0,1]. Put   another way, a plaintiff is awarded  =  . Punitive damages are no longer awarded.

d.  Now, what is the equilibrium price and quantity?

2.   Consider the same inverse market demand and inverse market supply functions presented in Question 1 above. However, now suppose that consumers misperceive the risk of        harm. In particular, consumers assess the probability to be 0.2. Firms correctly perceive   the probability to be 0.1. Harm is fixed and still $10,000. Assume that courts do not err    when awarding compensatory damages. Punitive damages are not awarded.

a.   What is the equilibrium price and quantity under no liability?

b.   What is the equilibrium price and quantity under strict liability?

c.   What is the reduction in economic surplus resulting from using no liability as opposed to strict liability as the liability rule? Hint: use geometry, or if you’re feeling frisky, use integral calculus.

3.   Consider the unilateral model of precaution. Recall that only the injurer can influence  accident prevention in this model. Suppose the unit cost of precaution is $1. The           probability of an accident is given by () =   !". $% , where  ≥ 0 is the level of         precaution. When an accident occurs, the victim suffers a fixed $10,000 in harm.          Although the liability rule is strict liability, the injurer escapes detection (and hence     liability) with a probability of 0.75. For simplicity, assume there are no litigation costs.