Suppose car sellers know if the car they are selling is good or bad, but buyers

Question

Suppose car sellers know if the car they are selling is good or bad, but buyers do not. Half of all potential sellers have good cars, and half of all potential sellers have bad cars. Sellers of good cars value their car at 10,000 and sellers of bad cars value their car at 2,000. Buyers value good cars at 15,000 and bad cars at 3,000. Which of the following is a possible transaction price for cars? (As in the lemons problem in class, buyers value cars at the expected dollar value, given what kinds of cars are available in equilibrium.) (Hint: possible transaction price means at less than or equal to buyers’ valuations and greater than or equal to sellers’ valuations)

Explanation / Answer

Answer:

Sellers average price: (10,000+2000) = 12000/2 = 6000

Buyers average price: (15000 + 3000) =18000 /2 = 7000

In the absence of information about the quality of the cars, only bad cars will be in the market for sale, as the expected good car-seller’s price is higher than the average price of cars in the market.

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