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An Intertemporal Model of Warranties

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Abstract

Using a simple two-period model, this paper attempts to explain certain 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 expected life of the product it covers? We view warranties as a partial solution to the double moral hazard problem that arises when buyers cannot readily observe the quality built into a product, and sellers cannot observe the care with which buyers use it. The optimal warranty strikes the right balance between providing incentives for seller quality and for buyer care. Under certain conditions, a two-period warranty will even render the first-best (i.e. full information) solution achievable.

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  • Tom Ross & Russell Cooper, 1986. "An Intertemporal Model of Warranties," Carleton Industrial Organization Research Unit (CIORU) 86-01, Carleton University, Department of Economics.
    • Handle: RePEc:car:ciorup:86-01
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    Cited by:

    1. Philip H. Dybvig & Nancy A. Lutz, 1993. "Warranties, Durability, and Maintenance: Two-sided Moral Hazard in a Continuous-Time Model," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(3), pages 575-597.
    2. Anyangah, Joshua O., 2017. "Creditor rights protection, tort claims and credit," International Review of Law and Economics, Elsevier, vol. 52(C), pages 29-43.
    3. Giorgio Coricelli & Luigi Luini, 1999. "Double Moral Hazard: an Experiment on Warranties," CEEL Working Papers 9901, Cognitive and Experimental Economics Laboratory, Department of Economics, University of Trento, Italia.
    4. Lutz, Nancy A., 1995. "Ownership rights and incentives in franchising," Journal of Corporate Finance, Elsevier, vol. 2(1-2), pages 103-131, October.

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