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Warranties as Signals Under Consumer Moral Hazard

In this paper, I examine whether and how warranties serve as signals of product quality in an environment where there are opportunities for consumer moral hazard. My model is very similar to Grossman's. A risk neutral monopolist produced a good of fixed and exogenous quality. This product is offered to a market of identical risk-averse consumers, and it can be bundled with a warranty of the monopolist's choosing. The probability that the product breaks down is a function of its quality and the effort the consumer takes in using it. This consumer effort cannot be observed by the monopolist or any third party, so that the warranty cannot be made conditional on the effort taken, and in choosing the warranty the monopolist must take the moral hazard problem into account.

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File URL: http://cowles.econ.yale.edu/P/cd/d08b/d0867.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 867.

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Length: 42 pages
Date of creation: Mar 1988
Date of revision:
Publication status: Published in Rand Journal of Economics (Summer 1989), 20(2): 240-255
Handle: RePEc:cwl:cwldpp:867
Note: CFP 739.
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Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. 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.
  2. 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.
  3. Grossman, Sanford J. & Perry, Motty, 1986. "Perfect sequential equilibrium," Journal of Economic Theory, Elsevier, vol. 39(1), pages 97-119, June.
  4. Farrell, Joseph, 1986. "Meaning and Credibility in Cheap-Talk Games," Department of Economics, Working Paper Series qt4968n3fz, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Robert Gertner & Robert Gibbons & David Scharfstein, 1987. "Simultaneous Signaling to the Capital and Product Markets," Working papers 449, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
  7. 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.
  8. 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.
  9. Heal, Geoffrey, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 549-60, October.
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