Question

Consider Problem 1 again. Suppose all the producers sell toasters through Wal-Mart, and WalMart lets producers choose from 2 options. With Option A, a producer sells a toaster at $49 but has to offer a free warranty to the consumer. With Option B, a producer sells a toaster at $10 without any warranty. A free warranty means that if a customer's toaster breaks, then she can return it and the producer must give her a full refund. (The returned good is of no use to anyone and will be dumped.) a. Which option will a low-quality producer choose, A or B? Justify numerically. b. Which option will a high-quality producer choose, A or B? Justify numerically. c. Will offering a free warranty send a useful signal to the consumer in this case? Why?

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

1. A low-quality producer will not provide any warranty, because he knows there will be more warranty claims.

He will choose option B.

Example:

Option B:

Toaster sell 100

Price $10

Sales = $1000

Profit = $100 (let's say it costs him $9 to make it).

Toaster sell 35 (as 5 times high price).

Price $49

Sales = $1725

Warranty Expense (let's say, due to multiple times claims) = $1500

Profit = -$90 (let's say it costs him $9 to make it).

2. A high-quality producer will provide any warranty because he knows there will be very very few warranty claims.

He will choose option B.

3. Yes, offering free warranty will send a positive signal to customers that the brand is providing quality product & it trusts its product.