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Credence Goods, Risk Averse, and Optimal Insurance

Ouyang, Yaofu (2016): Credence Goods, Risk Averse, and Optimal Insurance.

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Abstract

We analyze a credence goods market with risk averse consumers when the assumptions of both liability and verifiability hold. In the basic model, we show that the consumer's risk-aversion would induce expert's overtreatment behavior and thus cause social inefficiency. But the probability of overtreating deceases with the degree of consumer's risk-aversion or the coefficient of absolute risk aversion(CRRA). Furthermore, we extend the basic model with insurance option. We assume there exists a perfectly competitive insurance market where the consumer could purchase insurance. Two sets of equilibria indexed by expert's pricing strategy could be specified. The equilibrium outcome shows that the expert always behaves honestly and social efficiency can always be achieved in the equilibrium.

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