1. In the market for used cars, half of the cars are of good quality and would s
ID: 1225324 • Letter: 1
Question
1. In the market for used cars, half of the cars are of good quality and would sell for $8,000, while half of the cars are of poor quality and would sell for $6,000. If a buyer possessed no information about the quality of the car she was considering, what would she be willing to pay for it?
A) $8,000
B) $7,000 (incorrect answer)
C) $6,000
D) The buyer would choose not to buy because of the lack of information
Please explain how to solve this question. My book said (1/2x$)+(1/2x$) but that gave me 7,000 which is incorrect.
2. Which is an example of asymmetric information?
A) an employer not knowing which job candidate will do the best job
B) a buyer using a compiled report on the quality of a used car
C) a shopper using Internet reviews to help her decide which washing machine to purchase
D) a doctor prescribing a medication for a patient (incorrect answer)
3. A real estate agent who is paid on a contingency fee may not reduce moral hazard as well as a lawyer paid on a contingency fee because:
A) the lawyer is bound by an oath to represent her client well.
B) the real estate agent's contingency fee is based on time to sale completion. (incorrect answer)
C) the real estate agent's payment is smaller, therefore he may not wait for the best offer on his client's house.
D) the lawyer's job takes much longer to complete, therefore she will work harder.
Explanation / Answer
1 D) The buyer would choose not to buy because of the lack of information
Information asymmetry arises when the parties to a transaction do not have the same degree of information necessary to make an informed decision. As in the given question, in the market for used cars, the buyer generally cannot ascertain the value of a vehicle accurately and may therefore only be willing to pay an average price (which is equal to (1/2x$)+(1/2x$ = $7000) for it, somewhere between a bargain price and a premium price.
However, this tilts the scales in favor of a lemon seller, since even an average price for this lemon would be higher than the price it would command if the buyer knew beforehand that it was indeed a lemon. This phenomenon also puts the seller of a good used car at a disadvantage, since the best price such a seller can expect is an average price, and not the premium price the car should command.
Hence in the end only poor quality car will remain in the market and the buyer would choose not to buy because of the lack of information.
2 A) an employer not knowing which job candidate will do the best job.
Asymmetric information is a situation in which one party in a transaction has more or superior information compared to another and has an incentive to hide that information.
S0, option D is n't correct as doctor doesn't have incentive to hide the patient's health information from her/him.
and B and C are remedial measure for assyemtric information.
3 C) the real estate agent's payment is smaller, therefore he may not wait for the best offer on his client's house.
If you don't understand anything then comment, i'ill revert back on the same. :)
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