Socially Optimal Liability Rules for Firms with Natural Monopoly

Abstract

It has been shown by Polinsky and Shavell that the strict liability rule is socially superior to the negligence liability rule when firms are injurers, strangers are victims, and accidents have a unilateral nature if prefect competition among firms prevails. This article considers the problem of socially efficient liability rules in a market where natural monopoly prevails due to decreasing average cost. We especially consider a quasi-competitive case where average cost pricing is achieved in a naturally monopolized market either through well-organized government regulation or the weak invisible hands of contestability. In contrast to the perfectly competitive economy, the present article shows that in most cases, the negligence regime is socially more desirable than the strict liability regime from the view point of economic efficiency.

Keywords: strict liability, negligence, natural monopoly, average cost pricing

JEL Classification: K13, K2