Product SafetyProduct Safety

TechnologyTechnology

VersusVersus

BehaviorBehavior

Information ProblemInformation Problem

Occurs when safety/performance aspects of Occurs when safety/performance aspects of a product cannot be observed in advancea product cannot be observed in advance

Experience with good provides information Experience with good provides information but risks harm to the consumerbut risks harm to the consumer

Remedies:Remedies: After-the-fact: Consumer Complaints, Product After-the-fact: Consumer Complaints, Product

LiabilityLiability Before-the-fact: Regulation with Fines/PenaltiesBefore-the-fact: Regulation with Fines/Penalties Intermediate: Disclosure requirements, Intermediate: Disclosure requirements,

Government provision of information Government provision of information

Consumer Complaints, Product Consumer Complaints, Product Liability LitigationLiability Litigation

Consumer suffers loss Consumer suffers loss firstfirst May create proper incentives in long runMay create proper incentives in long run No enforcement costs (for government)No enforcement costs (for government) Appropriate whenAppropriate when

Loss from failure is small or highly uncertainLoss from failure is small or highly uncertain No technological solution existsNo technological solution exists Losses excludableLosses excludable

Example: product defectsExample: product defects

RegulationRegulation

Standards imposed Standards imposed beforebefore loss incurred loss incurred May create proper incentivesMay create proper incentives Enforcement costs incurredEnforcement costs incurred Appropriate whenAppropriate when

High costs of failureHigh costs of failure Technological solutions existTechnological solutions exist ““Lemons problem” is presentLemons problem” is present Losses not excludable (externalities)Losses not excludable (externalities)

Example: prescription drugs, anti-lock Example: prescription drugs, anti-lock brakesbrakes

Disclosure/Information ProvisionDisclosure/Information Provision

Provide information, but allow consumer Provide information, but allow consumer choicechoice

Influence behavior (choice) with Influence behavior (choice) with informationinformation

Appropriate whenAppropriate when No technological solution (inherently risky)No technological solution (inherently risky) Low cost of failureLow cost of failure Losses are excludableLosses are excludable

Examples: alcohol, cigarettes, o-t-c Examples: alcohol, cigarettes, o-t-c drugsdrugs

Why won’t markets work?Why won’t markets work?

““Lemons” marketLemons” market Bad drives out the goodBad drives out the good Consumers only observe average safety, so are Consumers only observe average safety, so are

unwilling to pay for high safety goodsunwilling to pay for high safety goods Solution: brand names build reputations for Solution: brand names build reputations for

qualityquality Free-rider problemFree-rider problem

Enjoy safe behavior/choices of othersEnjoy safe behavior/choices of others Drivers of unsafe cars benefit from others Drivers of unsafe cars benefit from others

driving safe cars – reduced risk of accidentdriving safe cars – reduced risk of accident

Pre-testing and approval: FDAPre-testing and approval: FDA

Product testing should minimize total Product testing should minimize total costs to society (t*)costs to society (t*)

Bureaucrats may not weigh costs this Bureaucrats may not weigh costs this wayway B’s cost of approving unsafe drug > cost B’s cost of approving unsafe drug > cost

of delaying safe drugsof delaying safe drugs Reg. agency chooses “too much” testing Reg. agency chooses “too much” testing

(t(tBB>t*)>t*) If cost of delay goes up, accelerated If cost of delay goes up, accelerated

approval process adopted (t* declines)approval process adopted (t* declines)

Technology vs. BehaviorTechnology vs. Behavior

Safer products may lead to more unsafe Safer products may lead to more unsafe behavior (“moral hazard”)behavior (“moral hazard”)

Example: Seat beltsExample: Seat belts Safer technology reduces P(Death) at any Safer technology reduces P(Death) at any

speedspeed Reduced P(D) induces increase in speedReduced P(D) induces increase in speed Safety improvement less than expectedSafety improvement less than expected

SUV’s encourage less safe driving, more SUV’s encourage less safe driving, more accidentsaccidents

““Safer” cigarettes cause more smokingSafer” cigarettes cause more smoking