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

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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File URL: http://cowles.econ.yale.edu/P/cd/d09a/d0922.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 922.

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Length: 18 pages
Date of creation: Aug 1989
Date of revision:
Publication status: Published in Review of Economic Studies (1993), 60: 575-597
Handle: RePEc:cwl:cwldpp:922
Contact details of provider: Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
Phone: (203) 432-3702
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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. Heal, Geoffrey, 1977. "Guarantees and Risk-Sharing," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 549-60, October.
  2. 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.
  3. 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.
  4. 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.
  5. Emons, Winand, 1988. "Warranties, moral hazard, and the lemons problem," Journal of Economic Theory, Elsevier, vol. 46(1), pages 16-33, October.
  6. Russell Cooper & T.W. Ross, 1984. "Product Warranties and Double Moral Hazard," Cowles Foundation Discussion Papers 716, Cowles Foundation for Research in Economics, Yale University.
  7. 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.
  8. Spence, A Michael, 1977. "Consumer Misperceptions, Product Failure and Producer Liability," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 561-72, October.
  9. 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.
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