Price competition and Reputation in Credence Goods Markets: Experimental Evidence

The project entitled "Price competition and Reputation in Markets for Goods of Trust: Experimental Evidence", completed in cooperation with the European Centre for Liberal Professions, received the Young Economists' Essay Award which is awarded by the conference of the European Economic Association for Research in Industrial economics (EARIE).

This conference is the most important and largest one in the field of industrial economics. The Young Economists' Essay Award, which is endowed with 1.000 Euro, is awarded once a year from the conference for projects that are very innovative and do have an outstanding professional content. The jury is composed of industrial economists that are recognised world-wide. 

 

Content of the project:

In many markets in which liberal professions exist credence goods are traded. Credence goods are goods which are characterised by the fact that the customers do not know what quality of the product is deemed to be acceptable. However, an expert is able to assess what quality the customer requires. Such information asymmetry among expert and client may result in the client being defrauded by the expert. For example, the expert may be tempted to perform a service that is more expensive than necessary, to invoice services not rendered or to perform badly. Due to the information asymmetry the client is not able to discover the fraud (an exception must be made in the case of underperformance).

A typical example of a market in which freelances offer their services is the health care market. In this case the physician is better informed about the illness than the the client, ie the patient. Another example is the case of lawyer and client - here the client is not able to determine whether initiating proceedings is the right course of action.

The aim of the experiment is to determine if the incentive to defraud clients is connected to the fact that prices in the market are either fixed or flexible. Additionally, it will be examined if the detail that markets do have a private or public reputation plays a role in the incentive to defraud. While the public reputation is connected to the client's possibility to identify the expert, the private reputation is characterised by the fact that the client learns about other clients' experiences.

The question if and how price regulation may influence the incentive for experts to defraud is essential for drafting the framework for markets. If the price regulation leads to a lower level of fraud and therefore increases the efficiency of the market, this may be a reason to intervene in the market. In Addition to that it is of great importance whether the public repuation, eg feedback websites offered by German statutory health insurance companies, is contributing to a lower level of fraud by experts.

 

Results of the project:

Experts such as lawyers or physicians are much less likely to defraud their clients in price regulated markets than in the situation of price competition. In markets with flexible prices quality is often disregarded due to price pressure which in turn leads to a higher rate of fraud by experts. Furthermore, it is shown that a higher grade of public information about the experts' behaviour does not deter them from defrauding their clients. If anything, in a market dominated by flexbile prices this information adds to the price pressure and is therefore responsible for a higher level of fraud. However, in a market characterised by fixed prices the additional information adds to the quality competition and, as a consequence, recudes the incentive to defraud.