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

Author

Listed:
  • 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)

Abstract

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.

Suggested Citation

  • David Hakes & Dongsoo Shin, 2008. "Warranties as a device to extract rent from low-risk users of a product," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(1), pages 1-7.
    • Handle: RePEc:wly:mgtdec:v:29:y:2008:i:1:p:1-7
    DOI: 10.1002/mde.1367
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    References listed on IDEAS

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