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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 consider a market in which an expert must exert costly but unobservable effort to identify the service that meets the consumer's need. In our model, experts offer competing contracts and the consumer may gather multiple opinions. We explore the incentives that a competitive sampling of prices and opinions provides for experts to exert effort and find that there is a tension between price competition and the equilibrium effort. In particular, the equilibrium fails to realize the second best welfare optimum. An intervention, that limits price competition via price control, increases welfare. Copyright The Review of Economic Studies Limited, 2003.

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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 1306.

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Date of creation: Aug 2000
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Handle: RePEc:nwu:cmsems:1306

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  1. Asher Wolinsky, 1991. "Competition in a Market for Informed Experts' Services," Discussion Papers 959, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Wolfgang Pesendorfer & Asher Wolinsky, 2003. "Second Opinions and Price Competition: Inefficiency in the Market for Expert Advice," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 417-437, 04.
  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. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
  5. Winand Emons, 1994. "Credence Goods and Fraudulent Experts," Diskussionsschriften dp9402, Universitaet Bern, Departement Volkswirtschaft.
  6. Wolinsky, Asher, 1983. "Prices as Signals of Product Quality," Review of Economic Studies, Wiley Blackwell, vol. 50(4), pages 647-58, October.
  7. Jacob Glazer & Thomas G. McGuire, 1991. "The Economics of Referrals," Papers 0020, Boston University - Industry Studies Programme.
  8. 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.
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