WARRANTIES, EXTENDED WARRANTIES, AND PRODUCT QUALITY

We analyze the effect of extended warranties on a manufacturer's warra nty policy under conditions of producer moral hazard. When all consume rs in the market are identical, the manufacturer offers a full warrant y. If consumers differ in their valuations of a working unit, then the manufacturer may offer partial warranties (and low quality) to low va luation consumers, and full warranties (and high quality) to high valu ation consumers. The availability of extended warranties from an indep endent insurer has an important effect on this menu of warranty/qualit y choices. Ii such an insurer enters the market, the manufacturer may increase ol decrease the warranty, price, and quality that it offers l ow valuation consumers. The result can be an increase in the manufactu rer's profits. (C) 1998 Elsevier Science B.V.