(30 points, 10 points each) It costs $10 to produce a low-quality wallet and $20

Question

(30 points, 10 points each) It costs $10 to produce a low-quality wallet and $20 to produce a high-quality wallet. Consumers cannot distinguish between the products before purchase, do not make repeat purchases, and value the wallets at the cost of production. The five firms in the market produce 100 wallets each. Each firm produces only high-quality or only low-quality wallets. Consumers pay the expected value of a wallet. Show your work. 6. a) If all five firms make low-quality wallets how much would consumers pay per wallet? b) If one firm makes high-quality wallet and all the others make low-quality wallet, what is the expected value per wallet to consumer? c) How many firms would produce high-quality wallet?

Explanation / Answer

a) If all the five firms make low-quality wallets, the consumer would pay $10 per wallet as the consumers pay the expected value of a wallet (they value the at the cost of production). So consumers pay $10 per wallet.

b) If one firm makes high quality wallet and other firms make lo quality wallet,

the expected value per wallet = 10*4/5 + 20*1/5 = $12 ( as 4 out of 5 firms have a cost of 10 per wallet and 1 firms out o 5 firms have a cost of 20 per wallet so expected value =  10*4/5 + 20*1/5)

so expected value per wallet to consumer = $12.

c) As one firm produce high quality wallet and rest 4 produces low quality so the profit of 4 firms making low quality wallet will rises ($12- $10), but the firm which produce the high quality wallet will bear loss as consumer will pay $12 and the firm's cost is $20. So no firm will produce high quality wallet.

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