A Note on the Optimality of Domain-specific Liability

Abstract This note analyzes the socially optimal allocation of liability when both consumers and the environment incur harm from the activity of a monopolistic firm. We show that the marginal welfare effect from a greater extent of loss shifting depends on the domain of harm (consumer vs. environment) and the relationship between the harm level and the level of output (proportional vs. non-proportional). Starting from the relevant benchmark of full compensation in both domains, reducing the firm’s liability for environmental harm is welfare-improving whereas reducing the firm’s liability for consumer harm is welfare-decreasing when harm increases more than proportionally with the quantity produced.