The market for lemons Consider a market in which there are many potential buyers
ID: 1213052 • 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 10,500 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. uppose that 80 percentage of sellers have low-quality cars. Assume buyers know that 80 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 dollar 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? Moral hazard Signaling Screening Adverse selectionExplanation / Answer
From the table we can see that the expected value of a car to a buyer is $6500 which is higher than the the expected selling price of a low quality car and lower than the expected selling price of a high quality car. Therefore, only sellers with low quality cars will be willing to participate in this market in that price.
The dilemma in this problem is an example of adverse selection.
Car Quality Probability (P) Expected Selling Price (S) Expected Buying Price (B) Expected Value of a Car to a Buyer (V) Low (L) 80% 4500 5500 V=LP*LB+HP*HB High (H) 20% 8500 10500 6500Related Questions
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