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

  • 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)

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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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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  1. Emons,Winand, 1986. "On the limitation of warranty duration," Discussion Paper Serie A 41, University of Bonn, Germany.
  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. Emons, Winand, 1989. " The Theory of Warranty Contracts," Journal of Economic Surveys, Wiley Blackwell, vol. 3(1), pages 43-57.
  4. 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.
  5. Schmalensee, Richard, 1982. "Commodity Bundling by Single-Product Monopolies," Journal of Law and Economics, University of Chicago Press, vol. 25(1), pages 67-71, April.
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  7. repec:tpr:qjecon:v:104:y:1989:i:2:p:371-83 is not listed on IDEAS
  8. 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.
  9. Kubo, Yuji, 1986. "Quality uncertainty and guarantee: A case of strategic market segmentation by a monopolist," European Economic Review, Elsevier, vol. 30(5), pages 1063-1079, October.
  10. Thomas J. Holmes, 1984. "Monopoly Bundling of Warranty and Quality When Quality is Unobservable," Discussion Papers 612, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. 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.
  12. 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.
  13. Spence, A Michael, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 561-72, October.
  14. Schmalensee, Richard, 1984. "Gaussian Demand and Commodity Bundling," The Journal of Business, University of Chicago Press, vol. 57(1), pages S211-30, January.
  15. repec:tpr:qjecon:v:90:y:1976:i:4:p:630-49 is not listed on IDEAS
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