It is well known that the Akerlof "lemons" problem may occur when sellers possess private information about product quality and that the use of warranties as prepurchase quality signals may mitigate both the informational asymmetry and the attendant market failure. There is, however, evidence suggesting that consumers rarely read and compare alternative warranties before reaching a purchase decision, which casts doubt on the role of warranties as prepurchase quality signals. This paper examines an environment in which the cost to consumers of interpreting warranty terms is prohibitively high so that warranties do not serve in a prepurchasing signalling capacity. Nonetheless, I find that firms will offer warranties in this environment and that the market outcome is often Pareto superior, and never Pareto inferior, to an equilibrium where warranties serve as prepurchase quality signals.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics
- Management, Monitoring, Policy and Law