Faculty Publications

Warranties As A Device To Extract Rent From Low-Risk Users Of A Product

Document Type

Article

Journal/Book/Conference Title

Managerial and Decision Economics

Volume

29

Issue

1

First Page

1

Last Page

7

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.

Department

Department of Economics

Original Publication Date

1-1-2008

DOI of published version

10.1002/mde.1367

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