This paper explores the interaction between product liability and vertical product differentiation when product safety is perfectly observable. In a two-stage competition, two firms are subject to strict liability and segment the market (i.e., consumers with heterogeneous harm levels) such that a low-safety product is marketed at a low price to consumers with relatively small harm levels whereas the safer product is sold at a high price to consumers with high levels of harm. Firms’ expected liability payments are critically influenced by how the market is segmented, creating a complex interaction between product liability and product differentiation. We vary the liability system’s allocation of losses between firms and consumers.
Shifting more losses to firms increases the safety levels of both products, may harm or benefit consumers (both on the individual and the aggregate level), and is not always socially optimal.
(Coauthors: Tim Friehe, and Alexander Rasch)