Optimal procurement of a credence good under limited liability

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 analyze the implications of separating diagnosis and treatment for efficiency and consumer surplus.