Faced with a reputation for producing automobiles with poor repair records, a nu
ID: 1228086 • Letter: F
Question
Faced with a reputation for producing automobiles with poor repair records, a number of American companies have offered extensive guarantees to car purchasers(e.g., a seven-year warranty on all parts and labor associated with mechanical problems).
In light of your knowledge of the lemons market, why is this a reasonable policy?
A.
An extensive warranty is more costly for the producer of a low-quality automobile than the producer of a high-quality automobile. Thus, only high-quality producers will offer them.
B.
An extensive warranty allows the producer of automobiles to charge a higher price without having to address the underlying quality issues.
C.
An extensive warranty is less costly for the producer of a low-quality automobile than the producer of a high-quality automobile. Thus, only low-quality producers will offer them.
D.
An extensive warranty is costly for producers of automobiles, but it is typically less costly than fixing the underlying quality problems. Thus, low-quality producers will offer them in lieu of offering a higher-quality vehicle.
Explanation / Answer
B.
An extensive warranty allows the producer of automobiles to charge a higher price without having to address the underlying quality issues.
People will be ready to buy such cars where they get enough warranty.
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