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Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening

Steven Matthews
John Moore

Abstract

We address the monopoly problem of designing and pricing a product line of goods distinguished by different quality and warranty levels. Consumers vary in their evaluations of these attributes, so that the problem is one of screening. It is sufficiently complex that the local approach commonly used does not work. Instead, we use new techniques for dealing with incentive constraints between nonadjacent consumer types. These techniques allow us to characterize optimal allocations that may not be monotonic. In particular, although the more eager types of buyer do pay higher prices and yield the monopoly higher profit, they may receive lower quality or lower warranty overage. We find preference restrictions that restore monotonicity: concave risk tolerance implies that warranty coverage increases in type, and constant absolute risk aversion implies that quality increases in type.