2. The market for lemons Consider a market in which there are many potential buy

Question

2. The market for lemons Consider a market in which there are many potential buyers and sellers of used cars. Each potential seller has one car, which is either of high quality (a plum) or low quality (a lemon). A seller with a low-quality car is willing to sell it for $5,000, whereas a seller with a high-quality car is willing to sell it for $9,500. A buyer is willing to pay $6,000 for a low- quality car and $11,500 for a high-quality car. Of course, only the seller knows whether a car is of high or low quality, as illustrated in the accompanying image: SAL Suppose that 80% of sellers have low-quality cars. Assume buyers know that 80% of sellers have low-quality cars but are unable to determine the quality of individual cars If all sellers offer their cars for sale and buyers have no way of determining whether a car is a high-quality plum or a low-quality lemon, the expected value of a car to a buyer is $ value of a low-quality car and the probability of getting a high-quality car multiplied by the value of a high-quality car) (Hint: The expected value of a car is the sum of the probability of getting a low-quality car multiplied by the Suppose buyers are willing to pay only up to the expected value of a car that you found in the previous question Since sellers of low-quality cars are willing to sell for $5,000, while sellers of high-quality cars are willing to sell for $9,500, will be willing to participate in this market at that price

Explanation / Answer

Expected value = 0.80*6,000 + 0.20*11,500 = $7,100

Buyers of Low Quality Car

Adverse selection

If you don't understand anything, then comment, I will revert back on the same.

And If you liked the answer then please do review the same. Thanks :)

Related Questions

Navigate

• Browse (All)
• Browse 2
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.