1. Individual Problems 20-1

Your product fails about 2% of the time, on average. Some customers purchase the extended warranty you offer in which you will replace the product if it fails. Suppose that you have currently set the price of the extended warranty at 2% of the product price.

An analyst at your company argues that after purchasing the extended warranty, customers are less likely to exercise caution when using the product because they will know that they can get their product replaced.

The analyst is claiming that _________ (adverse selection/ moral hazard)   will cause the claim rate to be  __________ (higher/ lower)   than 2%.

True or False: You should keep the price of the extended warranty at 2% of the product price.

True

False

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