Warranties, moral hazard, and the lemons problem (Q1106076)

This paper analyzes the following problem. Consumers cannot observe product quality at the time of purchase so that only warranties can induce firms to supply high-quality products. Yet, if consumers can adjust the care with which they use products, the presence of warranties may result in more frequent product failure. The paper studies what kinds of contracts will be offered in a competitive market characterized by such a double-sided moral hazard problem.