Warranties as Signals under Consumer Moral Hazard


Nancy A. Lutz

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Discussion Paper

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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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