Everybody out of the pool: Products liability, punitive damages, and competition

We examine how punitive damages and competitive forces generate equilibria which reveal the safety of a product. We model the monopoly (duopoly) provision of a product whose safety is unobservable to consumers prior to purchase, but is known by the firm(s) and can be signaled via the product's price and safety claims. Consumers' likelihood of purchase is based on the price and claim combination(s) they observe, thereby reducing the incentive for mimicry of the safer product by the less safe one. Nevertheless, absent punitive damages, there is a broad portion of the parameter space wherein no revealing equilibria exist. We characterize the minimal punitive damages necessary to ensure revelation; moreover, we find that competition reduces the minimal level of punitive damages. Competition and punitive damages are complementary in that they jointly make consumer choice more effective by creating conditions under which revealing equilibria can exist.