Review of Industrial Organization
12: 399–411, 1997.
1997 Kluwer Academic Publishers. Printed in the Netherlands.
Product Durability and Moral Hazard
GREGORY E. GOERING
Department of Economics, P.O. Box 756080, University of Alaska, Fairbanks, Alaska 99775–6080,
Abstract. Previous durability studies conclude that a monopolist that sells output without any com-
mitment ability will tend to produce output with lower durability than a monopolist that rents output.
This paper demonstrates that this conclusion depends critically on the degree of moral hazard (pos-
sible damage to output) faced by renting ﬁrms. When moral hazard abuse or neglect is introduced
in a durability model it is shown that a renter may manufacture output with lower durability than an
uncommitted seller reversing the conventional obsolescence result. However, the analysis indicates
that, unlike the seller’s commitment problem, the presence of moral hazard in rental markets does
not cause a failure of the independence of durability and industry structure.
Key words: Durable goods monopolist, moral hazard.
A number of papers have analyzed the phenomena of planned obsolescence and
commitment power in monopolistic durable goods markets. Coase (1972) ﬁrst
noted the commitment problem facing a monopoly seller of a durable good. Buyers
recognize that the seller has no interest in future periods to take into account the
capital loss on the existing stock of durables (as price is decreased) since this stock
is not owned by the ﬁrm. A renter on the other hand will internalize this capital loss
since it owns the stock at each point. This implies that a seller faces a commitment
or dynamic consistency problem that is not present if output is rented.
Bulow (1982, 1986), among others, shows that this commitment (dynamic
consistency) problem induces a monopoly seller without commitment power to
decrease product durability below efﬁcient levels, i.e., below the level of a renter.
Hence uncommitted sellers are typically assumed to practice planned obsolescence
in an attempt to mitigate their commitment problem with buyers.
The author gratefully acknowledges the helpful comments and suggestions of two anonymous
referees and the general editor on an earlier draft of this paper. Any remaining errors are solely the
As is well known, there are a variety of contractual remedies which may help mitigate the
seller’s commitment problem completely such as best price guarantees (e.g., Butz, 1990). Likewise
there may be contractual instruments which ease the renters’ moral hazard problem such as lease
restrictions on maintenance and upkeep (both of these are common in the automobile and housing
leasing markets). However, Bulow’s (1982, 1986) uncommitted sales analysis, by deﬁnition, assumes
the ﬁrm cannot commit or contract with potential buyers. Thus for consistency the current analysis
abstracts from contracting in the rental market to compare the benchmark rental case under moral