Assume the market for used cars is set up as in the table below. There are two t

ID: 1197257 • Letter: A

Question

Assume the market for used cars is set up as in the table below. There are two types of cars: lemons and peaches. Peaches are more reliable than lemons and thus have a higher value to both buyers and sellers. Sellers know the quality of their car, but buyers cannot distinguish between the two. Buyers are risk neutral and only care about the average quality of the cars on the market. Assume that the seller has more bargaining power and cars will sell at the buyer’s value. Everyone has the information in the table, but the buyers only know the percentage of cars that are lemons. Perfection Information Prices Peach (reliable) Lemon (unreliable) Buyer’s Value $15,000 $10,000 Seller’s Value $13,000 $8,000 Suppose 20% of the cars are lemons. At what price will cars sell? Input only your numerical answer below. Give the number only with no dollar sign.

Explanation / Answer

Perfection Information Prices

Peach (reliable)

Lemon (unreliable)

Buyer’s Value

$12,500

$9,300

Seller’s Value

$11,000

$8,250

The market clears at the buyer’s value and the buyers can access that value, so peaches sell for 12,500 and lemons sell for 9300.