A risk-neutral consumer is deciding whether to purchase a homogeneous product fr

Question

A risk-neutral consumer is deciding whether to purchase a homogeneous product from one of two firms. One firm produces an unreliable product and the other a reliable product. At the time of the sale, the consumer is unable to distinguish between the two firms’ products. From the consumer’s perspective, there is an equal chance that a given firm’s product is reliable or unreliable. The maximum amount this consumer will pay for an unreliable product is $0, while she will pay $90 for a reliable product.

a. Given this uncertainty, what is the most this consumer will pay to purchase one unit of this product?

b. How much will this consumer be willing to pay for the product if the firm offering the reliable product includes a warranty that will protect the consumer?

Explanation / Answer

A) Here the answer is straight forward, The risk of getting a bad product is 50%, So certainly the buyer will pay 50% of the price of product

$90-50%= 45

45 is the maximum price he would pay

B) He will pay the full price for the product, He can buy it at $90.

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