A buyer wants a used lap top, and values good ones at $1, 200 and bad ones at $5
ID: 1202385 • Letter: A
Question
A buyer wants a used lap top, and values good ones at $1, 200 and bad ones at $500. Sellers of good laptops values then at $900 and bad ones at $600. The buyer cannot observe the quality prior to purchase. If half the sellers are good and half the sellers are bad, what is the expected value for the buyer? a. $450 b. $750 c. $850 d. $1050 Consider the used laptop market in question 1. But now assume that only 35% of the potential sellers are good and the rest are bad. Then in this market, the buyer would be willing to pay up to $ if both sellers sell, but since this is the seller's valuation of good ones, the market suffers from adverse selection. a. 745; more than b. 950; more than c. 950; less than d. 745; less thanExplanation / Answer
Q1. Value to buyer of Good laptop = $1,200
Value to buyer of bad laptop = $500
It has been stated that half the sellers are good and half the sellers are bad.
This implies that,
Probability of getting a good laptop = 1/2
Probability of getting a bad laptop = 1/2
Calculate expected value for the buyer -
Expected Value = (Value to buyer of Good laptop * Probability of getting a good laptop) + (Value to buyer of bad laptop * Probability of getting a bad laptop)
Expected Value = ($1,200 * 1/2 + $500 * 1/2) = $600 + $250 = $850
Thus, the expected value for the buyer is $850.
Hence, the correct answer is option (c).
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