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Diagnostic Uncertainty and Insurance in Credence Goods Markets

Loukas Balafoutas (), Helena Fornwagner (), Rudolf Kerschbamer (), Matthias Sutter () and Maryna Tverdostup ()

Working Papers from Faculty of Economics and Statistics, University of Innsbruck

Abstract: Credence goods markets - like health care or repair services - with their informational asymmetries between expert sellers and uninformed customers are prone to fraudulent behavior of sellers and resulting market inefficiencies. Only little is known so far about how diagnostic uncertainty of sellers affects market outcomes, and how one widespread feature of such markets, insurance on the customer side, interacts with the degree of diagnostic uncertainty. We present a model that analyzes the effects of both diagnostic uncertainty and insurance in a unified framework and we test the model's predictions in lab experiments. Both in theory and in the experiment diagnostic uncertainty increases the rate of incorrect service provision and leads to less trade, thus reducing efficiency. In theory, insurance also increases the provision of incorrect services, but at the same time it also increases the volume of trade leading to an ambiguous net effect on welfare. In the experiments the net effect of insurance coverage on efficiency turns out to be negative. We also find an important interaction effect: if consumers are insured, experts invest less in diagnostic precision.

Keywords: Credence goods; experiment; diagnostic uncertainty; insurance coverage; welfare (search for similar items in EconPapers)
JEL-codes: C91 C72 D82 G22 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2020
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