Warranties, extended warranties, and product quality

Abstract

We analyze the effect of extended warranties on a manufacturer's warranty policy under conditions of producer moral hazard. When all consumers in the market are identical, the manufacturer offers a full warranty. If consumers differ in their valuations of a working unit, then the manufacturer may offer partial warranties (and low quality) to low valuation consumers, and full warranties (and high quality) to high valuation consumers. The availability of extended warranties from an independent insurer has an important effect on this menu of warranty/quality choices. If such an insurer enters the market, the manufacturer may increase or decrease the warranty, price, and quality that it offers low valuation consumers. The result can be an increase in the manufacturer's profits.