Undertreatment in credence goods markets: When does a no liability rule outperform?

Undertreatment, i.e., providing a minor treatment for a serious problem, may provide a partial benefit or may further worsen the actual condition. This paper studies the implications of undertreatment on a credence goods expert's pricing and treatment strategies and on the social welfare under two different liability regimes: strict liability rule and no liability rule. We characterize conditions under which a no liability rule is more socially efficient compared to a strict liability rule. When an expert's diagnosis is accurate, a no liability rule is efficient compared to a strict liabilit y rule unless the cost of serious treatment is relatively low or there is sufficient loss from undertreatment. Consequently, if undertreatment increases the loss from the serious problem, the strict liability rule results in higher social welfare than the no liability rule. In the presence of diagnosis errors, the strict liability rule leads to no trade, and the no liability rule is more efficient than the strict liability rule when the probability of the serious problem is low. This holds irrespective of whether undertreatment results in benefit or harm to the serious problem.