Liability in Markets for Credence Goods

We study the role of liability in disciplining an expert's behavior in a credence good market. The expert, who can provide two potential treatments for a consumer's problem, may misbehave in two ways: prescribing the "wrong" treatment given his private information, or failing to exert proper effort to diagnose the problem. We show that under a range of liability rules, the expert will choose the efficient treatment based on his information if the price margins for the two treatments are close enough. Moreover, a well-designed liability rule can motivate the expert to choose efficiently both the treatment and the diagnosis effort. This efficiency result continues to hold when the expert's diagnosis effort generates only a noisy signal about the nature of the consumer's problem, provided the signal is sufficiently informative