If damages are consistently assessed to be 10% lower than the actual harm done...

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First, let's restate the scenario and the options to ensure clarity. The situation posits that damages are consistently assessed at 10% below the actual harm done. We are asked how this affects precaution under two liability regimes: strict liability and negligence.
Option A claims: this would lead to less than efficient precaution under either a strict liability or a negligence rule. Here, the key idea is that undercompensation reduces the expected cost of harm for the party taking precautions, which typically weakens incentives to prevent harm. If true for both regimes, it would indeed yield underinvestment in precaution in either case. However, the statement forgets that under negligence, the incentive to exercise reasonable care is tied to avoiding liability through a standard of care and potential damages, and the effect of understated damages may not translate identically. This makes the blanket claim overly broad and not precisely aligned with typical theoretical nuance.
Option B proposes: this would lead to more than efficient precaution under either a strict liability or negligence rule. This would imply that undercompensation somehow makes parties overinvest in safety, which runs counter to standard economic reasoning about liability. When damages are understated, the perceived cost of harm decreases, reducing the incentive to invest in precaution, not increasing it. Therefore, this option is conceptually implausible in both liability frameworks.
Option C asserts: this would lead to less than efficient precaution under strict liability, but might still lead to efficient precaution under a negligence rule. Let’s unpack this carefully. Under strict liability, the actor bears the cost of harm regardless of fault, so compensation being 10% too low reduces the actor’s burden and lowers the marginal cost of precaution, typically producing underinvestment relative to the social optimum. That aligns with the idea of “less than efficient precaution” under strict liability. Under a negligence rule, however, the standard of care and the fault-based duty create incentives that depend on the expected liability from falling short of the standard. If damages are understated, the plaintiff’s potential recovery is smaller, which could soften the incentive to avoid negligence, but the legal standard of care and the possibility of courts applying a socially appropriate standard might still prompt efficient or near-efficient precautions in some cases, depending on how the standard of care interacts with the misvaluation of damages. In other words, the negligence regime could, in certain configurations, preserve or path to efficiency despite undercompensated damages, making it plausible that precaution could still be efficient under negligence even when it is not under strict liability.
Conclusion: Option C captures the plausible asymmetric effect—under strict liability, underinvestment due to undercompensation is straightforward, while under negligence there is room for the efficiency outcome to differ, potentially maintaining efficiency in some settings. The other two options make stronger, more global claims (either under both regimes or under neither) that conflict with standard theoretical expectations in liability economics.

SU25 ECON 522 001 ZFF Self Quiz, Week 4 part 2

If damages are consistently assessed to be 10% lower than the actual harm done...

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