Credence goods, costly diagnosis, and subjective evaluation

Helmut Bester and Matthias Dahm

No 2014/29, Discussion Papers from Free University Berlin, School of Business & Economics

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.

Keywords: credence goods; information acquisition; moral hazard; subjective evaluation (search for similar items in EconPapers)
JEL-codes: D82 D83 D86 I11 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Credence Goods, Costly Diagnosis and Subjective Evaluation (2018)
Working Paper: Credence Goods, Costly Diagnosis, and Subjective Evaluation (2014)
Working Paper: Credence Goods, Costly Diagnosis, and Subjective Evaluation (2014)
Working Paper: Credence Goods, Costly Diagnosis, and Subjective Evaluation (2014)
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