(a) First assume a liability rule of strict liability. Is

(a) First assume a liability rule of strict liability. Is the outcome Pareto efficient? Explain carefully. Does the outcome minimize social costs? Explain and compare value to prove your answer. 

(b) Next, assume a liability rule of simple negligence, where McDonald’s is considered negligent if it doesn’t take the highest level of care it can (Design 2). Is the outcome Pareto efficient? Kaldor-Hicks efficient? Explain carefully using the definitions of each.  

(c) Now assume a liability rule of no liability….answer the same questions.

(d) Now assume a liability rule of contributory negligence…answer the same questions. 

(e) Now assume a liability rule of comparative negligence… answer the same questions.

In Liebeck v McDonald’s (1994), Stella Liebeck suffered third-degree burns in her groin area when a cup of McDonald’s coffee spilled while she was in her car. Disregard any other information known about the McDonald’s case and suppose only the following information was known. McDonald’s had two options for producing their coffee cups. It turns out, their cups were produced using Design #1; however, they knew Design #2 was available. 

• Design #1: text “Caution: Hot” is printed in size 12, Times New Roman font, on the cup and costs a total of $100 to produce. 

• Design #2: text “Caution: VERY Hot” is printed in size 26, “cracked” font, on the cup, where adding the word “VERY” and changing the font to cracked costs a total of $160 to produce. As with Ms. Liebeck, suppose the potential accident that could occur is a consumer gets burned from McDonald’s hot coffee. Also assume the probability of this accident occurring depends only on McDonald’s actions. For now, suppose if Design #2 is used rather than Design #1, the probability of an accident decreases by 1% (1/100). Regardless of the type of design, suppose the cost of an accident was $10,000 for Ms. Liebeck.

Now, consider the strategic interaction between McDonald’s and Ms. Liebeck under different liability rules. Recall, the potential accident is Ms. Liebeck spills the coffee she purchases from McDonald’s. McDonald’s can either make cup Design 1 or cup Design 2. Ms. Liebeck can either be careful or be careless. You have been given McDonald’s costs, as well as the amount of harm done (assumed to equal damages), if the accident in fact occurs. 

• If Liebeck doesn’t take any care to prevent an accident, her costs are zero. 

• If Liebeck is careful, her costs are $800, meaning her implicit and explicit costs to ensuring the coffee doesn’t spill into her lap is $800. Now assume the probability of the accident occurring depends on both McDonald’s and Liebeck’s care levels. 

• If Design 1 is made and Liebeck is not careful, the probability of the accident is 50%. 

• If Design 1 is made and Liebeck is careful, or Design 2 is made and Liebeck is not careful, the probability of the accident is 25%. • If Design 2 is made and Liebeck is careful, the probability of the accident is 10%. 

• Regardless of the liability rule used, it turns out the court found McDonald’s was 80% liable and Liebeck was 20% liable. (Note, you don’t need this information for simple negligence or liability rules – only for fancier negligence rules that we didn’t cover). For each of the following tort regimes, (i) show the game in normal matrix form; (ii) solve for the Nash equilibrium. Show your work (legibly) to receive full credit.