If you are willing to pay $1400 for a used stereo that is a “cherry” and $280 fo

Question

If you are willing to pay $1400 for a used stereo that is a “cherry” and $280 for a used stereo that is a “lemon,” how much will you be willing to offer to purchase a stereo if there is a 50 percent chance that the stereo is a lemon? If owners of cherry stereos want $950 for their cherries, how will your estimate of the chance of getting a cherry change?

a. You would likely offer $1400 because you want a cherry. If sellers of cherries want $950, your $1400 would buy you only cherries, since you are offering $450 over the asking price.

b. You would likely offer $280 because you have a chance of buying a lemon and you need to reserve $670 for repairs. If sellers of cherries want $950, your $280 would sometimes buy you a lemon and sometimes buy you a cherry, since only the sellers know whether they are selling a cherry or a lemon.

c. You might offer the average, $840. If sellers of cherries want $950, your $840 would buy you only lemons, since only the seller knows whether they are selling a cherry or a lemon; thus, you would likely lower your asking price to reflect the fact that there are now only lemons in the market.

d. You would likely offer the average, $840. If sellers of cherries want $950, your $840 would buy you some lemons and some cherries, since only the sellers know whether they are selling a cherry or a lemon

Explanation / Answer

Option C

The reason is that even if the consumer doesn't know how much the seller is willing to accept. Thus, as per his/her knowledge, the best they can do is offer an average price for the product.

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