Monday, November 12, 2007
This paper considers the problem faced by a manufacturer who learns the product's risks after the product has already been sold and distributed to consumers. A product recall, where the manufacturer contacts old customers to warn them about the risks and (possibly) to offer to buy the product back, is costly to conduct. When held strictly liable for product-related injuries, the manufacturer solicits the return of the product when the product risk exceeds a threshold. Consumers comply with the recall and return the product when their private valuations of consumption are smaller than the buyback price. With strict liability alone, the manufacturer's private incentives to stage a recall are insufficient, the buyback price offered is too low, and the continued product usage by consumers is excessive. Strict liability with a warning defense, where the manufacturer can avoid liability by simply disclosing product risk, leads to too many product recalls but correct consumer usage following a recall. A carefully designed negligence based rule, the “post-sale duty to warn,” implements the social welfare benchmark.