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Policy consequences of limited cognitive ability

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  • Gilles Saint-Paul

Abstract

This paper analyses the welfare effects of price restrictions on private contracting in a world where agents have a limited cognitive ability. We deal with that by assuming that people compute the costs and benefits of entering a transaction with an error. We first discuss an example of an auction that will attract the least efficient buyers, because these are those who have made the largest mistake. We then study the case for government intervention when the government knows the distribution of true costs and benefits as well as that of errors. By imposing constraints on transaction prices, the government eliminates some that are on average inefficient - because the price signals that one of the parties has typically grossly overestimated its benefit from participation. This policy may increase aggregate welfare even though some of the transactions being blocked are actually efficient. Copyright Springer-Verlag Berlin/Heidelberg 2004

Suggested Citation

  • Gilles Saint-Paul, 2004. "Policy consequences of limited cognitive ability," Spanish Economic Review, Springer;Spanish Economic Association, vol. 6(2), pages 97-105, July.
    • Handle: RePEc:spr:specre:v:6:y:2004:i:2:p:97-105
    DOI: 10.1007/s10108-004-0080-8
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    Cited by:

    1. Sandro Ambuehl & B. Douglas Bernheim & Axel Ockenfels, 2019. "Projective Paternalism," NBER Working Papers 26119, National Bureau of Economic Research, Inc.

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