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Warranties, Durability, and Maintenance: Two Sided Moral Hazard in a Continuous-Time Model

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Author Info
Nancy A. Lutz (Dept. of Economics, Yale University)
Philip H. Dybvig (Washington University at St. Louis)

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Abstract

We consider the provision of an optimal warranty in a continuous-time model with two-sided moral hazard. The optimal warranty must balance the producer's durability incentive and the buyer's maintenance incentive. Too little warranty protection gives the producer too much incentive to produce low durability, while too much warranty protection gives the consumer too much incentive to neglect maintenance. The derived optimal warranty is a "block warranty" that is high for an initial block of time and zero thereafter. The first-best would be available under a very high warranty for a very short time interval, except for the incentive this would create for the consumer to abuse the product to collect the warranty.

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File URL: http://cowles.econ.yale.edu/P/cd/d09a/d0922.pdf
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Publisher Info
Paper provided by Cowles Foundation, Yale University in its series Cowles Foundation Discussion Papers with number 922.

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Length: 18 pages
Date of creation: Aug 1989
Date of revision:
Handle: RePEc:cwl:cwldpp:922

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Related research
Keywords: Warranties; moral hazard; incentives; product quality;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law & Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
  2. Emons, Winand, 1988. "Warranties, moral hazard, and the lemons problem," Journal of Economic Theory, Elsevier, vol. 46(1), pages 16-33, October. [Downloadable!] (restricted)
  3. Mann, D.P. & Wissink, J.P., 1989. "Hidden Actions And Hidden Characteristics In Warranty Markets," Department of Economics Working Papers 133, Department of Economics, Williams College.
  4. 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. [Downloadable!] (restricted)
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  5. 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. [Downloadable!] (restricted)
  6. Spence, A Michael, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Blackwell Publishing, vol. 44(3), pages 561-72, October. [Downloadable!] (restricted)
  7. Heal, Geoffrey, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Blackwell Publishing, vol. 44(3), pages 549-60, October. [Downloadable!] (restricted)
  8. Russell Cooper & Thomas W. Ross, 1988. "An Intertemporal Model of Warranties," Canadian Journal of Economics, Canadian Economics Association, vol. 21(1), pages 72-86, February. [Downloadable!] (restricted)
  9. Theodore Groves, 1974. "Information, Incentives and the Internalization of Production Externalities," Discussion Papers 87, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Li, Kunpeng & Chhajed, Dilip & Mallik, Suman, 2005. "Design of Extended Warranties in Supply Chains," Working Papers 05-0128, University of Illinois at Urbana-Champaign, College of Business. [Downloadable!]
  2. Aidan Hollis, 1996. "Exclusivity Restrictions in Markets with Adverse Selection: The Case of Extended Warranties," Working Papers ecpap-96-03, University of Toronto, Department of Economics. [Downloadable!]
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