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Warranties, Durability, and Maintenance: Two Sided Moral Hazard in a Continuous-Time Model

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We consider the provision of an optimal warranty in a continuous-time model with two-sided moral hazard. The optimal warranty must balance the producer's durability incentive and the buyer's maintenance incentive. Too little warranty protection gives the producer too much incentive to produce low durability, while too much warranty protection gives the consumer too much incentive to neglect maintenance. The derived optimal warranty is a "block warranty" that is high for an initial block of time and zero thereafter. The first-best would be available under a very high warranty for a very short time interval, except for the incentive this would create for the consumer to abuse the product to collect the warranty.

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  • Nancy A. Lutz & Philip H. Dybvig, 1989. "Warranties, Durability, and Maintenance: Two Sided Moral Hazard in a Continuous-Time Model," Cowles Foundation Discussion Papers 922, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:922
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    1. Theodore Groves, 1974. "Information, Incentives and the Internalization of Production Externalities," Discussion Papers 87, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    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. Russell Cooper & Thomas W. Ross, 1985. "Product Warranties and Double Moral Hazard," RAND Journal of Economics, The RAND Corporation, pages 103-113.
    4. Michael Spence, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 561-572.
    5. 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.
    6. Geoffrey Heal, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 549-560.
    7. Russell Cooper & Thomas W. Ross, 1988. "An Intertemporal Model of Warranties," Canadian Journal of Economics, Canadian Economics Association, vol. 21(1), pages 72-86, February.
    8. Emons, Winand, 1988. "Warranties, moral hazard, and the lemons problem," Journal of Economic Theory, Elsevier, vol. 46(1), pages 16-33, October.
    9. 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.
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    Cited by:

    1. Junhong Chu & Pradeep K. Chintagunta, 2009. "Quantifying the Economic Value of Warranties in the U.S. Server Market," Marketing Science, INFORMS, vol. 28(1), pages 99-121, 01-02.
    2. D Vandegrift, 2001. "Quality-Assuring Price And Breach Of Express Or Implied Warranty," Contemporary Economic Policy, Western Economic Association International, vol. 19(2), pages 186-196, April.
    3. Chen, Xu & Li, Ling & Zhou, Ming, 2012. "Manufacturer's pricing strategy for supply chain with warranty period-dependent demand," Omega, Elsevier, vol. 40(6), pages 807-816.
    4. Li, Kunpeng & Chhajed, Dilip & Mallik, Suman, 2005. "Design of Extended Warranties in Supply Chains," Working Papers 05-0128, University of Illinois at Urbana-Champaign, College of Business.
    5. Boom, Anette, 1998. "Product risk sharing by warranties in a monopoly market with risk-averse consumers," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 241-257, January.
    6. Lutz, Nancy A. & Padmanabhan, V., 1998. "Warranties, extended warranties, and product quality," International Journal of Industrial Organization, Elsevier, vol. 16(4), pages 463-493, July.
    7. Jun Yang, 2010. "Timing of Effort and Reward: Three-Sided Moral Hazard in a Continuous-Time Model," Management Science, INFORMS, vol. 56(9), pages 1568-1583, September.
    8. McClure, James & Kumcu, Erdogan, 2008. "Promotions and product pricing: Parsimony versus Veblenesque demand," Journal of Economic Behavior & Organization, Elsevier, vol. 65(1), pages 105-117, January.
    9. Aidan Hollis, 1996. "Exclusivity Restrictions in Markets with Adverse Selection: The Case of Extended Warranties," Working Papers ecpap-96-03, University of Toronto, Department of Economics.
    10. Eleonora Fichera & James Banks & Matt Sutton, 2014. "Health behaviours and the patient-doctor interaction: The double moral hazard problem," The School of Economics Discussion Paper Series 1415, Economics, The University of Manchester.
    11. 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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