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Economic Loss: Definition & Rule

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  • 0:01 What Is Economic Loss?
  • 0:34 Types of Economic Loss
  • 2:48 The Rule of Economic Loss
  • 4:41 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

This lesson will discuss economic loss and how it may affect individuals and organizations. The lesson will give a definition of economic loss, outline the types of economic loss, and then give details on how it may arise and how it may be addressed.

What Is Economic Loss?

Economic loss is a term used to describe circumstances when an individual or an organization loses money. The term covers financial loss that is usually visible in a balance sheet or other financial statements. While economic loss includes instances of loss in income suffered by a person or a business, it excludes any cases in which that loss of income is due to physical, personal injury. Economic loss may be caused by a natural disaster, such as a hurricane, or by the negligence of another party.

Types of Economic Loss

Because economic loss can take on so many different forms, economists use several divisions and sub-categories to further describe loss conditions. There are two main types of economic loss: pure economic loss and consequential economic loss.

Pure economic loss is usually defined as financial loss that excludes property damage. In other words, in cases of pure economic loss, the only thing that is lost is money. Examples of pure economic loss might include a loss of funds as a result of an investment not performing, the loss of business due to competitors' success, or the loss of goodwill in a community because of bad online reviews.

Consequential economic loss is directly caused by another event. In cases of consequential loss, the loss of money is a direct result of another loss or circumstance. Examples can include economic loss caused by property damage or the unsatisfactory performance of goods.

Let's look at a few examples of economic loss and decide whether each one is pure or consequential.

Allie is employed by a big box retailer. The store becomes flooded one day during a storm and the owners had to cease operations for five weeks. Allie is unemployed for those five weeks and, as a result, was not earning income.

Which type of economic loss is this? If you said consequential economic loss, you are correct! Allie's economic loss is a consequence of the storm's physical destruction of the store. Let's try another. Here's another example:

Jacob makes a $50,000 investment in a start-up company. A contract is drawn up stating that Jacob will be repaid $65,000 in five years. One year into the deal, the start-up company goes bankrupt and the entrepreneur behind it is imprisoned on charges unrelated to the business. Jacob is now out $50,000.

So, pure or consequential? What do you think? The answer is that this is an example of pure economic loss because the only thing that is lost is money. There is no physical damage or event that directly caused Jacob's loss.

The Rule of Economic Loss

Let's stay with Jacob for a second. After his start-up goes bankrupt, is his money gone forever? Is he just tough out of luck? Well, no, thank goodness he's not. Jacob may actually be able to recoup his investment. To do so, he would have to sue the start-up company and its owner. Fortunately, Jacob had a contract for this investment deal and so his chances of being able to get his money back are pretty good, according to the rule of economic loss.

The rule of economic loss states that the person or the business that experiences economic loss may recuperate damages for the loss based only on claims stemming from breach of contract. The rule also specifically addresses tort theory, also referred to as tort law or tort liability. Tort theory was created to compel an offender to restore the injured entity or party to its former state. In other words, it's a basis for a lawsuit that seeks to make everything right by compensating the plaintiff. The rule of economic loss, however, states that tort law may not be applied in economic loss cases.

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