The Effect of Product Misperception on Economic Outcomes: Evidence from the Extended Warranty Market
We use panel data on extended warranty purchases to investigate three potential drivers of the economic outcomes in this market: (1) pricing power due to consumers' search costs and the add-on feature of the warranty, (2) standard risk aversion, and (3) consumers' misperception of the insured product's failure probability. We estimate a model that incorporates these drivers, and perform counterfactual experiments to quantify their significance. We find that ``shutting down'' probability distortions leads to a decrease of more than 80\% in market volume and profit, and to a dramatic increase in consumer welfare. We also find that probability distortions are reduced with information and experience.
Jose Miguel Abito, Yuval Salant
Abito, Miguel Jose, and Yuval Salant. 2016. The Effect of Product Misperception on Economic Outcomes: Evidence from the Extended Warranty Market.