Optimal Warranties Under Asymmetric Information

When firms have private information on the quality of their own products, the warranty offered by a firm can convey information about product quality. Warranties also provide consumers with insurance should the product fail. Consumers face a trade-off: the desired insurance may not provide firms with incentives to reveal actual quality. In this thesis I derive price and refund schedules under which firms have no incentive to misrepresent quality, and characterize the price-refund-quality choice which maximizes expected utility when consumers have no source from which to infer quality other than prices and refunds.;The consumers' problem is described in a model where firms have private information on the exogenously determined probability that a unit will fail. I then show that when firms can choose quality, and entry is free, competition will generate prices and refunds from which consumers can correctly infer quality. With identical firms and identical consumers, in equilibrium only one quality will be produced; product diversity emerges from consumer heterogeneity. If firms share a common technology, there exists a revealing price-refund pair for each possible quality; if technologies differ, and cost functions are also private, prices and refunds alone may not be sufficient to enable consumers to correctly infer quality, for particular levels of quality.;Both prices and refunds are increasing in quality, and refunds increase more rapidly. If utility is separable in income and the outcome of a purchase, higher income consumers pay higher prices, and receive better warranties, for more reliable goods. When consumers are risk averse in income, expected utility is lower than it would be were quality costlessly observable. If income and the good are perfect substitutes, the market outcome is independent of the distribution of information. This analysis provides a benchmark for assessing market outcomes. The cost to consumers of eliciting information in this fashion should be compared to that from other sources, both market instruments like advertising, which might be less costly, and mandated producer liability schemes.

Name thesis:degree_name

Ph D

Year dc:date.issued

1986

Author dc:creator

• Welling, Linda Arlene

• Economics
• Theory

Handle dc:identifier.uri

https://hdl.handle.net/20.500.14721/21125

OAI identifier oai:identifier

oai:uwo.scholaris.ca:20.500.14721/21125