Question

Consider the used-car market for the Ford Pinto described in class. There is now a surge in demand for used Pintos; buyers would now be willing to pay up to $17,000 for a peach and $7,000 for a lemon. All else remains identical to the example seen in class.

a. What price would buyers be willing to pay for a Pinto of unknown type if the fraction of peaches in the population, f, were 0.75?

b. Will there be a market for peaches if f=0.75? Explain.

c. What price would buyers be willing to pay if f were 0.5?

d. Will there be a market for peaches if f=0.5? Explain.

e. What is the minimum value of f such that the market for peaches does not collapse?

f. Explain why the increase in the buyers’ willingness to pay changes the threshold value of f, where the market for peaches collapse.

Answer 1

A) The answer lies in the expected value of the car= 0.75*17000 + 0.25*7000 = $14500

B) For this question, more info is required : Reservation Price of the owner. If reservation Price of owner<= 14500, then there will be a market for peaches, else the owner would not want to sell their peaches.

C) Based on similiar lines, as Part A is: 0.5*17000 + 0.5*7000= $12000

D) For this question, more info is required : Reservation Price of the owner. If reservation Price of owner<= 12000, then there will be a market for peaches, else the owner would not want to sell their peaches.

E) For this question, more info is required : Reservation Price of the owner.

F)  The increase in the buyers’ willingness to pay changes the threshold value of f, where the market for peaches collapse. This happens because we are dealing with expected value which includes the factor of lemon. With increase in purchase amount, the threshold is shifted down (graphically), leading to a greater producer surplus.