Products Liability and Competition Policy when Firms Share a Collective Reputation

Abstract: We examine the implications of products liability in a setting where oligopolistic firms cannot differentiate themselves from rivals, but rather share a collective reputation for product safety. Aware of the industry's collective reputation, consumers know the average industry-wide likelihood of harm, but not the likelihood of harm of a particular firm's product. We characterize equilibrium accident probability, industry output, and social welfare under no liability and under strict liability for different assumptions about the extent to which consumers are compensated for harm in the case of accident. We show that, first, unlike in the traditional products liability model, firms' incentives to invest in precaution in general depend on the market structure. Second, no liability can welfare-dominate strict liability. Third, the relationship between social welfare and industry size depends on the legal regime in place. Under certain legal regimes, restricting industry size is unambiguously welfare-enhancing.