Warranties as Signals Under Consumer Moral Hazard

Nancy A. Lutz
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Nancy A. Lutz: Cowles Foundation, Yale University, https://cowles.yale.edu/

No 867, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: In this paper, I examine whether and how warranties serve as signals of product quality in an environment where there are opportunities for consumer moral hazard. My model is very similar to Grossman's. A risk neutral monopolist produced a good of fixed and exogenous quality. This product is offered to a market of identical risk-averse consumers, and it can be bundled with a warranty of the monopolist's choosing. The probability that the product breaks down is a function of its quality and the effort the consumer takes in using it. This consumer effort cannot be observed by the monopolist or any third party, so that the warranty cannot be made conditional on the effort taken, and in choosing the warranty the monopolist must take the moral hazard problem into account.

Keywords: Warranties; moral hazard; signalling; product quality; game theory (search for similar items in EconPapers)
Pages: 42 pages
Date: 1988-03
Note: CFP 739.
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Published in Rand Journal of Economics (Summer 1989), 20(2): 240-255

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