Abstract
Although government regulations on product warranties are common, few studies have empirically examined their effects on product demand. Using a natural experiment, we examine the effect of a newly introduced government warranty regulation in China’s automobile market on product demand. Exploiting the exogenous variation in warranty coverage caused by the regulation, we apply a difference-in-differences analysis and find that the regulation increases the sales of the affected vehicles. Moreover, we find that (1) the demand effects of the regulation decrease as vehicle quality increases, and that (2) these effects are weaker for luxury brand vehicles and stronger for non-luxury vehicles.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
See the news article “GM slices warranties, free service on Chevy, GMC” in USA Today. http://www.usatoday.com/story/money/cars/2015/03/12/gm-chevrolet-gmc-warranty-service-cut-reduced/70210660/.
We examine whether high-quality vehicles (i.e., vehicles with lower Initial Quality Survey (IQS) scores) tend to have higher prices in our dataset. To examine this, we run the following hedonic price regression: \(\ln ({p_{jt}})=\omega + \sigma IQS_{jt} +\varphi x_{jt} +\mu _{jt}\), where \(p_{jt} \) is the manufacturer-suggested retail price (MSRP) of vehicle j at time \(t; \omega \) is the constant; \(IQS_{jt} \) is the IQS score for vehicle j, which we use as a proxy for vehicle j’s quality; \(x_{jt} \) is the vector containing other observed vehicle characteristics for vehicle j (as listed in Table 1). \(u_{jt} \) is the error term that captures the unobserved vehicle characteristics that may affect vehicle prices. The estimation result gives the point estimate of \(\sigma \) 0.012, with standard error 0.694, suggesting that there is no systematic difference in prices across vehicles with different levels of quality. In other word, our analysis of heterogeneous effects of the warranty regulation among luxury and non-luxury vehicles is not confounded with the effects of the warranty regulation on vehicles with different quality levels.
Because a vehicle’s luxury status does not change over time, vehicle vintage-model fixed effects in our regressions control for the demand effects of vehicles’ luxury status.
For example, all major web portals in China (e.g., sina.com.cn, sohu.com) established special columns on this issue.
See the article on AQSIQ website: http://zlgls.aqsiq.gov.cn/cpzl/201412/t20141231_429384.htm (in Chinese).
MSRPs are set by manufacturers and are generally constant across cities and within a given vintage year. The MSRPs of vehicles in China include two types of taxes: a consumption tax, which ranges from 1 % for small-engine vehicles to 40 % for large-engine vehicles, and a value-added tax of 17 %.
In fact, our data set provides vehicle sales and characteristics at the trim level (e.g., 2011 vintage BMW 528Li vs. 2011 vintage BMW 535Li sedans) for each vintage-model vehicle (e.g., 2011 vintage BMW 5 series sedan). Therefore, in our analysis, we actually use the more detailed vintage-trim-level data. However, to follow industry conventions, we still refer to our data as being at the vintage-model level, even though they constitute a much more detailed data set.
Nevertheless, manufacturers can introduce certain upgrades within a vintage-model combination, such as powertrain upgrades or an exterior “facelift”, and if such upgrades occur, our data set treats the upgraded model as a new vintage.
Only 47 of 2185 vintage-model combinations in our data changed their warranty coverage, which were not required by the regulation.
Because we use only pre-regulation data and there is no within-vehicle change in the treatment status during the pre-regulation period, the model-vintage fixed effect \(\delta _j \) absorbs the effects of the treatment indicator.
The explanatory variables for the log regression are vehicles’ MSRPs, weight, length, width, height, wheelbase, fuel cost per kilometer, quality score, and engine horsepower as well as their quadratic terms. The pseudo-\(\hbox {R}^{2}\) of the logit regression is 0.359.
We thank an anonymous reviewer for suggesting the robustness checks in this section.
We also estimate specifications with vehicle quality scores in 2013 or 2014 as the quality measure in the interaction term and obtain very similar results.
We thank an anonymous reviewer for suggesting this analysis.
References
Ashenfelter, O. (1978). Estimating the effect of training program on earning. Review of Economics and Statistics, 60, 47–57.
Bertrand, M., Duflo, E., & Mullainanthan, S. (2004). How much should we trust difference-in-differences estimates? Quarterly Journal of Economics, 119, 249–275.
Brickey, K. F. (1978). The Magnuson–Moss Act: An analysis of the efficacy of federal warranty regulation as a consumer protection tool. Santa Clara Law Review, 18, 73–118.
Chu, J., & Chintagunta, P. (2009). Quantifying the economic value of warranties in the U.S. computer server and automobile market. Marketing Science, 28, 99–121.
Chu, J., & Chintagunta, P. (2011). An empirical test of warranty theories in the U.S. computer server and automobile markets. Journal of Marketing, 75, 75–92.
Choi, B., & Ishii, J. (2010). Consumer perception of warranty as signal of quality. Working paper, POSCO Research Institute.
Douglas, M., & Wildavsky, A. (1982). Risk and culture: An essay on the selection of technical and environmental dangers. Faculty Scholarship Series. New Haven, CT: Yale Law School.
Eissa, N., & Liebman, J. (1996). Labor supply response to the earned income tax credit. Quarterly Journal of Economics, 111, 605–637.
Emons, W. (1989). The theory of warranty contracts. Journal of Economic Surveys, 3, 43–57.
Galiani, S., Gertler, P., & Schargrodsky, E. (2005). Water for life: The impact of the privatization of water services on child mortality. Journal of Political Economy, 113, 83–119.
Guajardo, J. A., Cohen, M. A., & Netessine, S. (2012). Service competition and product quality in the U.S. automobile industry. Working Paper, Wharton School of Business, University of Pennsylvania.
Heal, G. (1977). Guarantees and risk-sharing. Review of Economic Studies, 44, 549–560.
Heckman, J., & Hotz, V. J. (1989). Choosing among alternative nonexperimental methods for estimating the impact of social programs: the case of manpower training. Journal of the American Statistical Association, 84, 862–880.
Kennedy, P. (1981). Estimation with correctly interpreted dummy variable in semilogarithmic equations. American Economic Review, 71, 801.
Klier, T., & Linn, J. (2010). The price of gasoline and new vehicle fuel economy: Evidence from monthly sales data. American Economics Journal: Economic Policy, 2, 134–153.
Kubo, Y. (1986). Quality uncertainty and guarantee: A case of strategic market segmentation by a monopolist. European Economic Review, 30, 1063–1079.
Lazar, E. (2014). Quantifying the economic value of warranties: A survey. Acta Universitatis Sapientiae, Economics and Business, 2, 75–94.
Li, S., Xiao, J., & Liu, Y. (2015). The price evolution in China’s automobile market. Journal of Economics & Management and Strategy, 24, 786–810.
Matthews, S., & Moore, J. (1987). Monopoly provision of quality and warranties: An exploration in the theory of multidimensional screening. Econometrica, 55, 441–467.
Menezes, M. A. J., & Currim, I. S. (1992). An approach for determination of warranty length. International Journal of Research in Marketing, 9, 177–195.
Meyer, B. (1995). Natural and quasi-experiments in economics. Journal of Business and Economic Statistics, 13, 151–161.
Padmanabhan, V., & Rao, R. C. (1993). Warranty policy and extended service contracts: Theory and an application to automobiles. Marketing Science, 12, 230–247.
Shimp, T., & Bearden, W. (1982). Warranty and other extrinsic cure effects on consumer risk perceptions. Journal of Consumer Research, 9, 38–46.
U.S. Department of Commerce. (1992). Product warranties and servicing: Responsive business approach to consumer needs. Washington, DC: U.S. Department of Commerce.
Acknowledgments
We would like to thank the Editor, Michael A. Crew, and two anonymous referees whose comments substantially improve the paper. We also acknowledge the financial support from the National Natural Science Foundation of China (Grant 71303148 and 71402088), the Humanity and Social Science Foundation of Ministry of Education of China (Grant 13YJC790126).
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Sun, Q., Wu, F. Warranty regulation and consumer demand: evidence from China’s automobile market. J Regul Econ 49, 152–171 (2016). https://doi.org/10.1007/s11149-015-9291-1
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11149-015-9291-1