Managerial Econ

The market for digital cameras is relatively new. Ajax Inc. produces what it regards as a
high-quality digital camera. Knockoff Inc. produces what it regards as a low-quality
digital camera. However, because the market is so new, reputations for quality have not
yet developed, and consumers cannot tell the quality difference between an Ajax digital
and a Knockoff digital just by looking at them.
If consumers knew the difference, they’d be willing to pay $200 for a high-quality
camera, and they’d be willing to pay $100 for a low-quality camera. It costs Ajax $85 to
produce a high-quality camera, and it costs Knockoff $55 to produce a low-quality
camera.
A recent MBA hire at Ajax suggests that Ajax could differentiate its
camera from Knockoff’s by offering a full-coverage warranty (which would fully cover
any defect in the camera at no cost to the customer). The MBA estimates that it would
cost Ajax $20 per year to offer such a warranty. The MBA also estimates that it would
cost Knockoff $40 per year should Knockoff attempt to copy Ajax’s warranty strategy.
Consumers will feel that the camera with the longest warranty is high-quality and that
with the shortest warranty is low-quality. The camera companies want to maximize the
profit per camera.