DOUBLE-SIDED ADVERSE SELECTION IN THE PRODUCT MARKET AND THE ROLE OF THE INSURANCE MARKET

Abstract

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.