Reference no: EM133125270

Imagine a world with two people: a potential victim and a potential injurer (victim and potential, thereafter). There is some probability the injurer will cause the victim some harm, A. Both of them can take precautions to lower the probability of having an accident. The social cost is thus wvxv + wixi + p(xv; xi)A; where wj is the agent ji´s unit precaution cost and xj is his level of precaution taken, j = v;i. And p(xv;xi) is the probability of having an accident.

a)Supposep(xv;xi)=1=(xi +1). Describethee¢ cientoutcome(regarding the choice of precaution levels).

b) Suppose p(xv;xi) = 1=(xi +xv +1). Describe the e¢ cient outcome (re- garding the choice of precaution levels). Consider these two cases: (i) wv = 2wi and (ii) wv = wi.

(Hint: the e¢ cient outcome is determined by minimization of the social cost.)