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Limited Rationality and Endogenously Incomplete Contracts

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  • Barton L. Lipman

Abstract

The purpose of this paper is to provided a simple model in which limited rationality endogenously generates incomplete contracts. I model limited rationality as in Lipman [1991,1992], focusing on the idea that boundedly rational agents do not necessarily know every implication of their knowledge, but may, at a cost, compute these implications. This assumption implies the existence of subjective uncertainty in addition to the objective uncertainty the agents are contracting over. The presence of noncontractable subjective uncertainty can lead to contracts which are incomplete with respect to the contractable objective uncertainty. The most surprising result is that strategic bargaining over contracts can lead to incomplete contracts even with infinitesimal computation costs.

Suggested Citation

  • Barton L. Lipman, 1992. "Limited Rationality and Endogenously Incomplete Contracts," Working Paper 858, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:858
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    File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_858.pdf
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    Cited by:

    1. Toru Suzuki, 2020. "Efficiently Imprecise Contracts," Working Paper Series 2020/07, Economics Discipline Group, UTS Business School, University of Technology, Sydney.
    2. Luca Anderlini & Leonardo Felli, "undated". ""Costly Coasian Contracts''," CARESS Working Papres 97-11, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
    3. Holm, Hakan J., 1995. "Computational cost of verifying enforceable contracts," International Review of Law and Economics, Elsevier, vol. 15(2), pages 127-140, June.
    4. Mehrdad Vahabi, 1999. "From Walrasian General Equilibrium to Incomplete Contracts: Making Sense of Institutions," Cahiers de la Maison des Sciences Economiques j99008, Université Panthéon-Sorbonne (Paris 1).
    5. Fares, M’hand, 2005. "Quels fondements à l’incomplétude des contrats?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 81(3), pages 535-555, Septembre.

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