Working Paper, Department of Economics, Johannes Kepler University of Linz 0509
This paper studies price competition between experts and discounters in a market for credence goods. While experts can identify a consumer’s problem by exerting costly but unobservable diagnosis effort, discounters just sell treatments without giving any advice. The unobservability of diagnosis effort induces experts to use their tariffs as signaling devices. This makes them vulnerable to competition by discounters. We explore the conditions under which experts survive competition by discounters and find that there exist situations in which adding a single customer to a large population of existing consumers leads to a switch from an experts only to a discounters only market. We also discuss whether vertical restraints can alleviate these inefficiencies.