This and the remaining chapters investigate hidden characteristic problems, from voting to used-car markets to kidney exchanges. We see that market forces have spawned contracts and other devices that induce agents to reveal their hidden characteristics. This does not mean that the equilibrium outcome is efficient in each case, however. There are incentive schemes that do induce truthful revelation of the hidden information while at the same time bringing the system close to efficiency—the Vickrey auction of Chapter 6 for instance.

Markets are wonderfully creative in circumventing hidden information problems. Warranties on consumer durables provide a nice example of the market system generating its own solution to a hidden characteristic problem. The producer of a shoddy appliance cannot afford to offer a substantial warranty. The point of producing a low-quality item is to get more profit by keeping costs down, but if many appliances are being returned for refund or repair then costs will be high, not low. A producer who deliberately sets out to profit by misleading consumers about the quality of the product will not be able to offer the same kind of warranty as the producer of a high-quality product. The producer of the high-quality item is signaling high quality to the consumer by offering a substantial warranty. Reputable manufacturers often make good on a warranty even after it has expired, as long as the appliance is returned a month or less after the expiration date.