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Credence Goods, Costly Diagnosis, and Subjective Evaluation

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  • Bester, Helmut
  • Dahm, Matthias

Abstract

We study contracting between a consumer and an expert. The expert can invest in diagnosis to obtain a noisy signal about whether a low–cost service is sufficient or whether a high–cost treatment is required to solve the consumer’s problem. This involves moral hazard because diagnosis effort and signals are not observable. Treatments are contractible, but success or failure of the low–cost treatment is observed only by the consumer. Payments can therefore not depend on the objective outcome but only the consumer’s report, or subjective evaluation. A failure of the low–cost treatment delays the solution of the consumer’s problem by the high–cost treatment to a second period. We show that the first–best solution can always be implemented if the parties’ discount rate is zero; an increase in the discount rate reduces the range of parameter combinations for which the first–best can be obtained. In an extension we show that the first–best is also always implementable if diagnosis and treatment can be separated by contracting with two different agents.

Suggested Citation

  • Bester, Helmut & Dahm, Matthias, 2014. "Credence Goods, Costly Diagnosis, and Subjective Evaluation," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 483, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  • Handle: RePEc:trf:wpaper:483
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    References listed on IDEAS

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    1. Bonroy, Olivier & Lemarié, Stéphane & Tropéano, Jean-Philippe, 2013. "Credence goods, experts and risk aversion," Economics Letters, Elsevier, vol. 120(3), pages 464-467.
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    6. Uwe Dulleck & Jiong Gong & Jianpei Li, 2015. "Contracting for Infrastructure Projects as Credence Goods," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 17(3), pages 328-345, June.
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    9. William Fuchs, 2007. "Contracting with Repeated Moral Hazard and Private Evaluations," American Economic Review, American Economic Association, vol. 97(4), pages 1432-1448, September.
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    11. Yuk-fai Fong, 2005. "When Do Experts Cheat and Whom Do They Target?," RAND Journal of Economics, The RAND Corporation, vol. 36(1), pages 113-130, Spring.
    12. Jeffrey Clemens & Joshua D. Gottlieb, 2014. "Do Physicians' Financial Incentives Affect Medical Treatment and Patient Health?," American Economic Review, American Economic Association, vol. 104(4), pages 1320-1349, April.
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    Cited by:

    1. Ouyang, Yaofu, 2016. "Credence Goods, Risk Averse, and Optimal Insurance," MPRA Paper 70392, University Library of Munich, Germany.
    2. Li, Jianpei & Ouyang, Yaofu, 2016. "Expert Costs and the Role of Verifiability," MPRA Paper 74390, University Library of Munich, Germany.

    More about this item

    Keywords

    credence goods; information acquisition; moral hazard; subjective evaluation;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets

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