Suppose that you decide to start offering an extended warranty on a product that you sell. Assume that the product fails 2% of the time. After you give the warranty, what is likely to happen to the number of products you have to replace under the warranty?

Indicate by answering True or False to below.

1. Due to moral hazard, buyers of your product will be more reckless after the purchase of the product, leading to higher replacement rate.
2. Due to adverse selection, buyers of your product will be more reckless after the purchase of the product, leading to a higher replacement rate.
3. Because of adverse selection, those who buy the product will likely be those who are more careful people, leading to a lower replacement rate.