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Optimal procurement of a credence good under limited liability

Helmut Bester and Ouyang Yaofu

No 2018/1, Discussion Papers from Free University Berlin, School of Business & Economics

Abstract: This paper analyzes the optimal contract for a consumer to procure a credence good from an expert when (i) the expert might misrepresent his private information about the consumer's need, (ii) the expert might not choose the requested service since his choice of treatment is non-observable, and (iii) limited liability of the expert precludes imposing penalty payments on him. We characterize payments under the optimal contract and show that, compared with the first-best, these induce inefficient undertreatment. We further show that separating diagnosis and treatment increases consumer surplus. Whether it decreases or increases the likelihood of undertreatment, however, depends on the accuracy of the expert's information.

Keywords: credence goods; non-observable treatments; hidden information; moral hazard; limited liability (search for similar items in EconPapers)
JEL-codes: D82 D83 D86 I11 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-law, nep-mic and nep-reg
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