1. Peach-Lemon problem Consider the market of used cars. Sellers have two types
ID: 1119387 • Letter: 1
Question
1. Peach-Lemon problem Consider the market of used cars. Sellers have two types of cars: peaches (cars in good condition) and lemons (cars in bad condition). If a potential buyer is able to identify quality of a car, his is willing to pay $10000 for a peach and S5000 for a lemon. On the other hand, sellers is willing to sell a peach at $7500 and a lemon at $4000 The game unfolds as below: first, sellers choose to sell or not, and at which price to sell. After that, potential buyers choose to buy or not. Find equilibrium decisions in the following situations: a. There are four times as many peaches as lemons (g4/5), (15 pts) b. There are four times as many lemons as peaches (q=1/5). (15 pts)Explanation / Answer
LEMON (q= 1/5)
PEACHES (q=4/5)
SELLERS
4,000
7,500
BUYERS
5,000
10,000
= $ 9000
So, $9,000 is the equilibrium price when there are four times as many peaches as lemons.
Owners of Peaches will sell their cars only if the expected value of buyers is greater than the selling price of peaches for sellers. Hence, the owners of peaches and lemons can sell their cars at $7,500 and $4,000 respectively.
2)
LEMON (q= 4/5)
PEACHES (q=1/5)
SELLERS
4,000
7,500
BUYERS
5,000
10,000
= $6,000
So, $6,000 is the equilibrium price when there are four times as many lemons as peaches.
Owners of Peaches will sell their cars only if the expected value of buyers is greater than the selling price of peaches for sellers. However, expected value $6,000 is less than the seller’s price and hence the owner of peaches will not sell their car. Buyers think lemon cars are worth 5,000 hence, sellers will sell their lemon cars at $4,000 since the expected value $6,000 is greater than the selling price of lemons at $4,000.
LEMON (q= 1/5)
PEACHES (q=4/5)
SELLERS
4,000
7,500
BUYERS
5,000
10,000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.