Suppose that there is asymmetric information in the market for used cars; seller

Question

Suppose that there is asymmetric information in the market for used cars; sellers know the quality of the car that they are selling, but buyers do not. Buyers know that there is a 40% chance of getting a "lemon", a low quality used car. A high quality used car is worth $20,000, and a low quality used car is worth $10,000. Based on this probability, the most that a buyer would be willing to pay for a used car is S (Enter your response rounded to the nearest dollar) At that price, which of the following is true? O A. There will only be low quality cars for sale. O B. There will be both high and low quality cars for sale. OC. There will only be high quality cars for sale. O D. It is not possible to determine the quality of cars that will be offered for sale.

Explanation / Answer

Solution 1) Buyer knows the probability of getting a lemon car = 40%
Price of high quality used car = $20,000
Price of low quality used car = $10,000
Therefore,
The most buyer would be willing to pay=40%*$10,000+(100-40%)*$20,000=$14,000

A) There will be low quality cars for sale.

Solution 2) Buyer knows the probability of getting a lemon car = 30%
Price of high quality used car = $30,000
Price of low quality used car = $15,000
Therefore,
The most buyer would be willing to pay=30%*$15,000+(100-30%)*$30,000=$25,500

B) High quality sellers could offer warranties or product guarnatees.

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