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How should judges decide contract cases when they realize that private parties know more about what is good for them than the judges themselves know? This is a crucial question in structuring contract law, because if judges knew private valuations, we could dispose of contracts altogether and simply let judges order welfare-maximizing trade. Savvy judges, however, realize that they are normally less informed than private litigants and will accordingly be prone to error in deciding cases. The famed "nirvana fallacy" appears when judges or commentators forget that it is difficult for third parties to identify the social optimum. How then should judges operating under conditions of relative ignorance avoid the nirvana fallacy?
My general (but rather uninteresting) answer is that judges deciding contract cases should harness the parties' private information. This is not a new answer. In some ways it is the idea behind the theory of efficient breach. Expectation damages encourage a promisor to breach only when her information tells her that breach is likely to be efficient.
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