Asymmetric information 1. You need transportation so you look for a used-motorcy

Question

Asymmetric information

1. You need transportation so you look for a used-motorcycle. You see an ad saying that a bike for sale is in perfect condition, almost never driven except by an old lady who used it to go to church on Sundays. Do you believe her? How does your faith (or disbelief) in his words effect the price you are willing to pay for the bike?

2. You are thinking of selling your old motorcycle. You have taken very good care of it and know that it is in very good condition and will serve a new owner very well. Do you think that potential buyers will believe you and will pay you a fair price? Why or why not?

Explanation / Answer

1. We donot believe on the advertisement as all the sellers of the product says that their product is not a lemon as there exist asymmetric information among the buyers and sellers. Sellers know the actual position of the product but to gain profit it always predict that good is in perfect condition.

When we got to know that the product is second hand and driven by someone else then it decreases our willingness to pay for the product. So, in this case after seeing ad that it is used by the old lady then buyer think that it must be damaged as it is driven by old lady so his willingness to pay for the motorcycle decreases.

2. If person is wanted to sell his old motorcycle then he demands price according to its good condition but buyer at the same time want to pay less as product is a lemon i.e. used by other. Willingness of buyer is less than the price which seller want to charge. If seller said that this is in very good condition and will serve you very well then potential buyer will not believe you and does not want to pay you a fair price. In this case, seller can signal about the quality of the product by giving buyer a long drive or insurance which will convince the buyer that motorcycle is actually in a good condition.

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