Competition, Product Safety, and Product Liability

Abstract A firm’s incentive to invest in product safety is affected by both market environment and product liability. We investigate the relationship between competition and product liability in a spatial model of oligopoly, where reputation provides a market incentive for safety investment and higher liability may distort consumers’ incentive for product care. We find that partial liability, together with reputation concerns, can motivate firms to make safety investment. Increased competition due to less product differentiation diminishes a firm’s gain from maintaining reputation and raises the socially desired product liability. On the other hand, an increase in the number of competitors reduces the benefit from maintaining reputation, but has a non-monotonic effect on the potential gain from cutting back safety investment; consequently, the optimal liability may vary non-monotonically with the number of competitors. In general, therefore, the relationship between competition and product liability is subtle, depending on how competition is measured. (JEL L13, L15, K13)