Add-on Pricing over Regional Business Cycles: Evidence from Extended Warranties

What explains apparent price rigidity over the business cycle? This paper shows that price fluctuations may be hidden in prices of add ons. Using 10 years of extended warranty data from a nationwide Canadian retailer, we show that extended warranty prices respond strongly to changes in local economic activity whereas prices of underlying durable goods do not. The pro-cyclicality is driven by a shift in price setting behavior, where local stores use extended warranty discounts to make base durable demand less price elastic and, as a result, increase sales of durable goods. Discounts on extended warranties were especially sharp during the Great Recession.