Three essays on product warranty
Abstract
The first essay compares two different types of warranty in which double moral hazard plays a key role. We extend Mann and Wissink (1990a) to include consumer's moral hazard. Our result shows that replacement warranty is offered when interest rates and transaction costs are low. We also compare the input levels between these contracts. If the seller and the third party cannot observe the product performance directly, the neutral third party scheme which achieves the first best outcome only exists under replacement warranty. The second essay investigates a combination warranty under two cases: (1) one sided moral hazard; (2) double moral hazard. Unlike the model in our first essay, we allow the seller to choose a combination warranty; i.e., the seller keeps replacing the product for the first few periods, but offers a refund and terminates the buyer-seller relationship after several periods if the product keeps failing. Our analysis shows that there does not exist any combination warranty in case (1) and (2) if actions are observable. With private information, combination warranty does not exist in case (1) since full insurance is always offered. It exists only with double moral hazard under a necessary condition: for the range of interest rates and transaction costs such that the pure replacement warranty dominates the pure money-back warranty. The efficiency loss can be ameliorated in the replacement periods through an optimal incomplete refund. The third essay compares money-back warranty and replacement warranty in an oligopolistic market. When quality is unobservable under money-back warranty, sellers will offer a complete refund. The buyer is indifferent between buying low quality and high quality product. A seller with lower transaction costs can drive out the other seller from the market by setting the product price below his rival's expected cost. In contrast to the money-back warranty, the buyer is not fully insured with replacement warranty. The seller with higher transaction costs may exist in the market by providing higher product quality. The various possible market outcomes are discussed when sellers can choose the type of warranty.
Degree
Ph.D.
Advisors
Hu, Purdue University.
Subject Area
Economic theory
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