An Intertemporal Model of Warranties

Tom Ross () and Russell Cooper
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Tom Ross: University of British Columbia, http://economics.ubc.ca/

Carleton Industrial Organization Research Unit (CIORU) from Carleton University, Department of Economics

Abstract: Using a simple two-period model, this paper attempts to explain certain interesting intertemporal properties of product warranties. Specifically, why does coverage generally fall over time and why is the typical warranty's life so much shorter than the expected life of the product it covers? We view warranties as a partial solution to the double moral hazard problem that arises when buyers cannot readily observe the quality built into a product, and sellers cannot observe the care with which buyers use it. The optimal warranty strikes the right balance between providing incentives for seller quality and for buyer care. Under certain conditions, a two-period warranty will even render the first-best (i.e. full information) solution achievable.

Pages: 22 pages
Date: 1986
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Journal Article: An Intertemporal Model of Warranties (1988)
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