Optimal Paternalistic Regulation of Markets

Abstract

Many markets are regulated for paternalistic reasons. We develop a mechanism-design framework to derive the optimal policy mix between price regulation and quantity controls. A budget-constrained planner allocates trade between privately informed buyers and sellers while disagreeing with their valuations. When the planner’s valuations preserve the ranking of agents, price instruments (e.g., sin taxes) are optimal. When the planner instead believes that a high willingness to trade indicates a bias, optimal regulation can restrict quantities or even prohibit transactions. De-biasing interventions offer two benefits beyond economic regulation: improving selection into markets and, for virtuous goods, raising the volume of trade.