Suppose there are two kinds of used cars which exist, good cars worth $20,000 to

Question

Suppose there are two kinds of used cars which exist, good cars worth $20,000 to the seller and $30,000 to the buyer, and bad cars (lemons) worth only $10,000 to the seller and 15,000 to the buyer. There are q(0, 1) regular cars and 1-q lemons. Also, suppose that only the owner truly knows the type of car that it is, both agents are risk neutral, and that cars can only be sold for one price p.

1.) Let µ denote the probability of buying a good car for the car that is actually sold (i.e., µ only equals q if all cars are sold). For which µ will the seller want to sell lemons? For which µ will the seller want to sell good cars? What does this imply about whether lemons, good cars, or both are sold in the market?

Explanation / Answer

an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is indifferent. That is, the consumer has no preference for one combination or bundle of goods over a different combination on the same curve. One can also refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer. In other words, an indifference curve is the locus of various points showing different combinations of two goods providing equal utility to the consumer. Utility is then a device to represent preferences rather than something from which preferences come.[1] The main use of indifference curves is in the representation of potentially observable demand patterns for individual consumers over commodity bundles.[2]

There are infinitely many indifference curves: one passes through each combination. A collection of (selected) indifference curves, illustrated graphically, is referred to as an indifference map.

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