TAKING ADVANTAGE OF UNINFORMED CONSUMERS: Evidence from 400 undercover taxi rides in Athens

If a taxi driver in an unfamiliar city knows that someone else is covering your fare, they are much more likely to charge you a higher price than is justified by the distance you are taken. That is one of the lessons from an economic experiment involving 400 undercover taxi rides in Athens, Greece.

The research by Loukas Balafoutas, Rudolf Kerschbamer and Matthias Sutter, published in the February 2017 issue of the Economic Journal, also finds that female customers are on average more susceptible to such fraudulent behaviour.

The study provides an example of a much wider problem in markets for ''credence goods'', where expert sellers know more about consumers'' needs than the consumers themselves: sellers can use this information to charge unjustifiably high prices or dupe their customers in other ways.

A surprisingly large number of goods and services that we consume on an everyday basis can be described as credence goods. Examples include medical services (where a doctor makes a diagnosis and orders a treatment); car or computer repair services (where a mechanic discovers a problem and recommends a solution); legal or financial services; taxi rides in unknown cities; and many others.

In these markets, if expert sellers exploit their informational advantage, they can increase their profits – for example, by providing an unnecessarily high quality or charging unjustifiably high prices. Such fraudulent behaviour creates damages to consumers and leads to economic inefficiencies.

The efficiency loss may be even more pronounced when the consumers do not have to bear the costs of the good or service themselves – for example, because they are insured or because someone else (an employer perhaps) is covering their costs. In that case, expert sellers may anticipate that customers are not particularly concerned with minimising costs, and consequently misbehave even more.

The researchers examined these issues in an economic experiment by taking 400 undercover taxi rides in Athens, Greece. Four assistants, acting as passengers on 11 different routes across the city, always revealed to the driver that they were unfamiliar with the city, thus giving the taxi ride the characteristic of a typical credence good.

The main experimental variation consisted solely of a short phrase in one ''treatment'', in which the passengers indicated that they needed a receipt in order to have their expenses reimbursed by their employer. Hence, these passengers conveyed the impression of not personally bearing the costs of the fare and therefore were perceived by the drivers as less likely to notice or report fraudulent behaviour.

This manipulation had an economically pronounced and statistically significant positive effect on taxi bills, with undercover passengers in that treatment 17% more likely to pay higher-than-justified prices for a given ride. Total consumer expenditures increased by an average of 6% when consumers indicated that someone else would be paying the bill. In addition, female customers were on average more susceptible to fraud and paying higher prices than men.

The researchers comment:

''Our findings are consistent with anecdotal evidence from the healthcare system. For example, the healthcare sector in Germany is allegedly prone to physicians inflating patients'' bills through adding services on the bill that have not been provided.''

''As a result, there is an incentive for funders to reduce the extent of the problem. For example, insurers in the medical industry sometimes hire their own doctors and pay them as a way to contain costs.''

''This suggests that the phenomena investigated in our study are a powerful problem in credence goods markets, which – at least in some sectors – has led to the design of fraud-restraining institutions.''

''Second-degree Moral Hazard in a Real-world Credence Goods Market'' by Loukas Balafoutas, Rudolf Kerschbamer and Matthias Sutter is published in the February 2017 issue of the Economic Journal. Loukas Balafoutas and Rudolf Kerschbamer are at the University of Innsbruck. Matthias Sutter is at the University of Cologne and the University of Innsbruck.