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Second Opinions and Price Competition Inefficiency in the Market for Expert Advice

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  • Wolfgang Pesendorfer
  • Asher Wolinsky

Abstract

We analyze a market where the consumer must rely on expers to identify the correct type of service. Medical services, repair services and various types of consulting and advisory services belong to this broad category. Our focus is on situations where the diagnosis of the consumer's needs is costly and the expert's effort is unobservable. We develop a model where experts offer competing contracts and consumers may gather multiple opinions. In various contractual settings, we explore the incentives that a competitive sampling of prices and opinions provides for experts to exert effort. We find that there is a tension between price competition and quality of the advise provided in equilibrium. Under all the contracting scenarios considered, the equilibrium fails to realize the second best welfare optimum. In some of the cases, no gains from trade are realized. On the other hand, limiting price competition via price control increases total welfare.

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1229.

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Date of creation: May 1998
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Handle: RePEc:nwu:cmsems:1229

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  1. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
  2. Asher Wolinsky, 1991. "Competition in a Market for Informed Experts' Services," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 959, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Pitchik, Carolyn & Schotter, Andrew, 1987. "Honesty in a Model of Strategic Information Transmission," American Economic Review, American Economic Association, vol. 77(5), pages 1032-36, December.
  4. Darby, Michael R & Karni, Edi, 1973. "Free Competition and the Optimal Amount of Fraud," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 67-88, April.
  5. Wolfgang Pesendorfer & Asher Wolinsky, 1998. "Second Opinions and Price Competition Inefficiency in the Market for Expert Advice," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 1229, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Winand Emons, 1997. "Credence Goods and Fraudelent Experts," RAND Journal of Economics, The RAND Corporation, vol. 28(1), pages 107-119, Spring.
  7. Wolinsky, Asher, 1983. "Prices as Signals of Product Quality," Review of Economic Studies, Wiley Blackwell, vol. 50(4), pages 647-58, October.
  8. Jacob Glazer & Thomas G. McGuire, 1991. "The Economics of Referrals," Papers 0020, Boston University - Industry Studies Programme.
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