Double-sided adverse selection in the product market and the role of the insurance market
I investigate the interrelation between a product market and an insurance market when adverse-selection problems exist both in consumers and in firms. Firms offer warranties for product failures. Consumers may further purchase first-party insurance for the residual risks of product failures. Given that the insurance market exists, two types of equilibria are possible: (a) Different firm types offer different pooling warranties attracting both good and bad consumer types or (b) good firms attract only bad consumers and bad firms attract both types of consumers. I discuss the existence and the efficiency implication of the insurance market. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.