The market for lemons Consider a market in which there are many potential buyers
ID: 1210656 • Letter: T
Question
The market for lemons Consider a market in which there are many potential buyers and sellers of used cars. Each potential seller has one car, which is either of high quality (a plum) or low quality (a lemon). A seller with a low-quality car is willing to sell it for dollar 4,500, whereas a seller with a high-quality car is willing to sell it for dollar 8,500. A buyer is willing to pay dollar 5,500 for a low-quality car and dollar 9,500 for a high-quality car. Of course, only the seller knows whether a car is of high or low quality, as illustrated in the accompanying image: Suppose that 85 percentage of sellers have low-quality cars. Assume buyers know that 85 percentage of sellers have low-quality cars but are unable to determine the quality of individual cars. If all sellers offer their cars for sale and buyers have no way of determining whether a car is a high-quality plum or a low-quality lemon, the expected value of a car to a buyer is s Suppose buyers are willing to pay only up to the expected value of a car that you found in the previous question. Since sellers of low-quality cars are willing to sell for dollar 4,500, while sellers of high-quality cars are willing to sell for dollar 8,500, will be willing to participate in this market at that price. The dilemma in this problem is an example of which of the following economic concepts? Adverse selection Moral hazard Signaling ScreeningExplanation / Answer
(a) Expected value = $5500 x 85% + $9500 x 15% = $(4675 + 1425) = $6100
(b) Low quality sellers will sell at this expected price.
(c) This situation is called an adverse selection.
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