An Intertemporal Model of Warranties

Using a simple two-period model, this paper attempts to explain uncertain 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 expec ted life of the product it covers? The authors view warranties as a p artial solution to the double moral hazard problem that arises when b uyers cannot readily observe the quality built into a product, and se llers cannot observe the care with which buyers use it. The optimal w arranty strikes the right balance between providing incentives for se ller quality and for buyer care. Under certain contitions, a two-peri od warranty will even render the first-best (i.e., full information) solution achievable.