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Warranties as Signals Under Consumer Moral Hazard

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    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.

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    File URL: http://cowles.econ.yale.edu/P/cd/d08b/d0867.pdf
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    Bibliographic Info

    Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 867.

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    Length: 42 pages
    Date of creation: Mar 1988
    Date of revision:
    Publication status: Published in Rand Journal of Economics (Summer 1989), 20(2): 240-255
    Handle: RePEc:cwl:cwldpp:867

    Note: CFP 739.
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    Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

    Related research

    Keywords: Warranties; moral hazard; signalling; product quality; game theory;

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    1. Grossman, Sanford J. & Perry, Motty, 1986. "Perfect sequential equilibrium," Journal of Economic Theory, Elsevier, vol. 39(1), pages 97-119, June.
    2. Russell Cooper & Thomas W. Ross, 1985. "Product Warranties and Double Moral Hazard," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 103-113, Spring.
    3. Farrell Joseph, 1993. "Meaning and Credibility in Cheap-Talk Games," Games and Economic Behavior, Elsevier, vol. 5(4), pages 514-531, October.
    4. Matthews, Steven & Moore, John, 1987. "Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening," Econometrica, Econometric Society, vol. 55(2), pages 441-67, March.
    5. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
    6. Gertner, Robert H. & Gibbons, Robert. & Scharfstein, David., 1987. "Simultaneous signaling to the capital and product markets," Working papers 1917-87., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    7. Heal, Geoffrey, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 549-60, October.
    8. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
    9. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
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