This paper analyses the welfare effects of price restrictions on private contracting in a world
where agents have a limited cognitive ability. People compute the costs and benefits of
entering a transaction with an error. 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.
The paper also studies the extent to which the use of private consultants with sufficient
intelligence by people with limited intelligence may dominate government regulation.
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