Max Planck Institute for Innovation and Competition, Munich, Room 313
In absence of perfectly enforceable contracts economic theory predicts largely inefficient market outcomes. The solution to this problem is twofold: either costly contracts and regulations or trust and reciprocal behavior both result in stable and efficient equilibria. “Satisfaction guaranteed”, promising a full refund to the discontent customer, serves as a trust building device which has previously been shown to significantly improve market performance. In this paper, however, we show that the previous models of full refund guarantees fail to capture important features for either side of the contract. As a matter of fact, the guarantee does not necessarily reduce but rather realign the transaction risks. We assume that the possible temporary utilization of the contracted good creates virtually no costs for the customer but imposes considerable transaction costs on the seller. This creates a situation where the benefits of increased transactions through reassured customers have to countervail the possible losses from fraud in order to facilitate an efficient market equilibrium.
Contact person: Marina Chugunova