Ex ante Investment, Ex post Remedy, and Product Liability

Yongmin Chen and Xinyu Hua

MPRA Paper from University Library of Munich, Germany

Abstract: Low-quality products may cause consumer harm. A firm can reduce the probability of low quality through ex ante investment before sales, and can take remedy actions such as product recalls if it learns after sales that product quality is low. An increase in the firm's product liability increases its incentive for ex post remedy; more ex post remedy, however, may reduce the firm's ex ante quality investment. On the other hand, higher product liability increases consumer demand for the product, resulting in high output and hence greater return to ex ante investment. The trade-off between these two effects, the "substitution effect" and the "output effect", can lead to an inverted U-shaped relationship between ex ante investment and product liability. We find that the firm always prefers full liability whereas consumers might be better off with less than full liability. Full product liability tends to be socially optimal when the potential consumer loss from low quality is sufficiently high; otherwise partial liability can be socially optimal.

Keywords: Ex ante Investment; Product Recall; Liability (search for similar items in EconPapers)
JEL-codes: K13 L15 (search for similar items in EconPapers)
Date: 2010-04-12
New Economics Papers: this item is included in nep-bec, nep-cta and nep-law
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https://mpra.ub.uni-muenchen.de/22381/1/MPRA_paper_22381.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:22031

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