Product risk sharing by warranties in a monopoly market with risk-averse consumers

Abstract

This paper analyzes the implications of three different warranty rules in a monopoly setting with risk-averse consumers. The necessary condition for the existence of the market is independent of the risk-sharing arrangement. Although the quantity consumed is the highest if the consumer receives no warranty, even if the monopolist is constrained to marginal cost pricing, the replacement warranty is most efficient from a risk allocation point of view. However, the situation with no warranty is Pareto-superior to a money back warranty. Additionally, the producer and the consumers agree on the ranking of the warranty rules.