Theoretical Analyses of Product Durability under Financial Constraint

Abstract

Durable goods are more likely to impose binding financial constraint than the perishable goods because they are usually relatively more expensive. Durable goods can also impose time inconsistency problem to the monopolist seller. This is because, after selling to the relatively high-valuation consumers today, the monopolist will cut price to sell to the low-valuation consumers in the future. Forwarding-looking consumers reduce their willingness to pay today, which negatively affects the monopolist's overall profitability. This thesis analyses the profit-maximizing behaviour of the durable-goods monopolist when binding financial constraint and time inconsistency problem coexist, and when the provision of financing is available to the budget-constrained consumers. I analyse two types of financing - sale on instalment plan and loan from profit-maximizing lending institution - separately, and then compare the welfare consequences of those two financing options. First, I show that, like leasing, selling on instalment plan not only weakens the severity of the binding financial constraint, but also resolves the time inconsistency problem. Second, loan from profit-maximizing lending institution can eliminate the binding financial constraint, but it does not resolve the time inconsistency problem. Nonetheless, lending happens only when the binding financial constraint is severe. Finally, I show that when the binding financial constraint is sufficiently severe, the monopolist is better off when loan from the lending institution is the financing option, compared to selling on instalment plan. This is because resolving the binding financial constraint is more beneficial than resolving the time inconsistency problem, and loan from lending institution is more effective in resolving it. I further extend the analysis by allowing the coexistence of the two financing options, and then discus the welfare consequences when the lending institution is the benevolent one compared to when it is the profit-maximizing one. I show that the consumer are worse off facing the benevolent lending institution compared to the profit-maximizing one. This is because when the lending institution is benevolent, the monopolist takes advantages of it by increasing price.