Suppose that there are two types of houses for sale: those with solid foundations and those with cracked foundations. In all other respects, the two types of houses are identical. Houses with solid foundations are worth $200,000, while those with cracked foundations are worth $200,000 minus the $20,000 to fix the crack, or $180,000. Sellers know which type of house they have, but buyers cannot detect whether the foundation has a crack. Suppose that 80 percent of the houses for sale have a solid foundation and 20 percent of the houses for sale have a cracked foundation. How could the owner of a house with a solid foundation credibly signal to potential buyers that the house has a solid foundation?
A)Keep the house on the market for $200,000 because eventually buyers will catch on.
B)Simply tell potential buyers that the foundation is solid.
C)Lower the asking price to $196,000.
D)Offer a warranty to fix any foundation problems that develop in the next 12 months.

Question

Quizplus · Accepted Answer

Offering a warranty is a credible signal of quality because it is more costly to offer a warranty if the house has a cracked foundation. Thus, this signal is "costly to fake".

Suppose That There Are Two Types of Houses for Sale