Warranties as a device to extract rent from low‐risk users of a product |
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Authors: | David Hakes Dongsoo Shin |
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Institution: | 1. Department of Economics, University of Northern Iowa, Cedar Falls, IA 50614, USA;2. Department of Economics, Santa Clara University, Santa Clara, CA 95053, USA |
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Abstract: | We develop a simple model that provides a new rationale for why a monopolist should bundle its product with a warranty even when all parties are risk neutral. In our model, a risk‐neutral monopolist faces two types of risk‐neutral consumers—low‐risk users that are unlikely to cause product failure and high‐risk users that are more likely to cause product failure. We find that when the firm fails to provide a warranty, a low‐risk user acquires a strictly positive rent by pretending to be a high‐risk user and receiving a price discount. By imposing a warranty, however, the monopolist can increase the price to high‐risk users, which in turn removes the incentive for a low‐risk user to pretend to be a high‐risk user, and the firm successfully extracts rent from the low‐risk user. Copyright © 2007 John Wiley & Sons, Ltd. |
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