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Warranties as a device to extract rent from low-risk users of a product

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  • David Hakes

    (Department of Economics, University of Northern Iowa, Cedar Falls, IA 50614, USA)

  • Dongsoo Shin

    (Department of Economics, Santa Clara University, Santa Clara, CA 95053, USA)

Abstract

We develop a simple model that provides a new rationale for why a monopolist should bundle its product with a warranty even when all parties are risk neutral. In our model, a risk-neutral monopolist faces two types of risk-neutral consumers-low-risk users that are unlikely to cause product failure and high-risk users that are more likely to cause product failure. We find that when the firm fails to provide a warranty, a low-risk user acquires a strictly positive rent by pretending to be a high-risk user and receiving a price discount. By imposing a warranty, however, the monopolist can increase the price to high-risk users, which in turn removes the incentive for a low-risk user to pretend to be a high-risk user, and the firm successfully extracts rent from the low-risk user. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/mde.1367
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Managerial and Decision Economics.

Volume (Year): 29 (2008)
Issue (Month): 1 ()
Pages: 1-7

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Handle: RePEc:wly:mgtdec:v:29:y:2008:i:1:p:1-7

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Web page: http://www3.interscience.wiley.com/cgi-bin/jhome/7976

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  1. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(4), pages 630-49, November.
  2. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 24(3), pages 461-83, December.
  3. Emons, Winand, 1989. " The Theory of Warranty Contracts," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 3(1), pages 43-57.
  4. Nancy A. Lutz, 1989. "Warranties as Signals under Consumer Moral Hazard," RAND Journal of Economics, The RAND Corporation, vol. 20(2), pages 239-255, Summer.
  5. Russell Cooper & T.W. Ross, 1984. "Product Warranties and Double Moral Hazard," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 716, Cowles Foundation for Research in Economics, Yale University.
  6. Kubo, Yuji, 1986. "Quality uncertainty and guarantee: A case of strategic market segmentation by a monopolist," European Economic Review, Elsevier, Elsevier, vol. 30(5), pages 1063-1079, October.
  7. Adams, William James & Yellen, Janet L, 1976. "Commodity Bundling and the Burden of Monopoly," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(3), pages 475-98, August.
  8. Schmalensee, Richard, 1984. "Gaussian Demand and Commodity Bundling," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 57(1), pages S211-30, January.
  9. Steven Matthews & John Moore, 1985. "Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 661, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. McAfee, R Preston & McMillan, John & Whinston, Michael D, 1989. "Multiproduct Monopoly, Commodity Bundling, and Correlation of Values," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(2), pages 371-83, May.
  11. Emons, Winand, 1989. "On the Limitation of Warranty Duration," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 37(3), pages 287-301, March.
  12. Mann, D.P. & Wissink, J.P., 1989. "Hidden Actions And Hidden Characteristics In Warranty Markets," Department of Economics Working Papers, Department of Economics, Williams College 133, Department of Economics, Williams College.
  13. Thomas J. Holmes, 1984. "Monopoly Bundling of Warranty and Quality When Quality is Unobservable," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 612, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Spence, A Michael, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 44(3), pages 561-72, October.
  15. Schmalensee, Richard, 1982. "Commodity Bundling by Single-Product Monopolies," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 25(1), pages 67-71, April.
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