The first part of the article sets up an economic model of both compensatory and punitive awards. The analysis shows the core function of punitive damages, at least where economically motivated actors are concerned, is to fill a gap in the deterrence of accident costs in a market economy. Such a gap occurs because the externalization of accident costs is not fully addressed by compensatory damages. The analysis also indicates there is a theoretically appropriate level of deterrence, such that the tort system becomes dysfunctional if legal rules lead to the imposition of either too much punitive damage liability or too little. The second part of the article deals with criticisms of economic calculations as the basis for analyzing punitive damages, while the third part of the article examines how the correct amount of punitive damages should be determined in a given case. The author concludes that the amount of punitive damage awards should be controlled primarily by economic analysis and that the ultimate measure should be the size of the deterrence gap created by the failure of injured persons to recover all losses. 341 footnotes