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A Simple Model of Reliability, Warranties, and Price-Capping

Author

Listed:
  • Donald A. R. George

    (Management School & Economics, University of Edinburgh, U.K.)

Abstract

The paper presents a model of reliability which captures the process by which reliability is actually determined more accurately than the conventional analysis. In contrast to that conventional analysis, which is based on the characteristics approach, the model of this paper defines reliability as the objective probability of product failure, not as a characteristic of individual goods. Reliability, thus defined, is treated as a choice variable of the firm. The resulting model is applied to a monopolist subject to a price cap. The monopolist can vary reliability and the terms of a warranty or compensation deal in response to price-capping. The monopoly outcome, price-capped monopoly outcome, and Pareto-efficient outcome are compared. The model provides a theoretical explanation of some empirical results in the literature on electricity regulation.

Suggested Citation

  • Donald A. R. George, 2006. "A Simple Model of Reliability, Warranties, and Price-Capping," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 5(1), pages 1-16, April.
    • Handle: RePEc:ijb:journl:v:5:y:2006:i:1:p:1-16
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    References listed on IDEAS

    as
    1. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, vol. 50(2), pages 443-459, March.
    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, vol. 24(3), pages 461-483, December.
    3. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August.
    4. Fraser, Rob, 1994. "Price, quality and regulation : An analysis of price capping and the reliability of electricity supply," Energy Economics, Elsevier, vol. 16(3), pages 175-183, July.
    5. Carl Shapiro, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(4), pages 659-679.
    6. 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 441-467, March.
    7. Matsukawa, Isamu & Fujii, Yoshifumi, 1994. "Customer Preferences for Reliable Power Supply: Using Data on Actual Choices of Back-Up Equipment," The Review of Economics and Statistics, MIT Press, vol. 76(3), pages 434-446, August.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

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    JEL classification:

    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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