Question

Consider a simplified market for the used 2015 Nissan Sentra. There are only two types of cars: great condition and poor condition. Suppose the less-informed buyers have no way of observing pertinent information at all about the quality of a car. Suppose each owner of a ‘great condition’ car values the car at $10,000 and each owner of a ‘poor condition’ car values the car at $5,000. Suppose buyers are willing to pay $12,000 for a ‘great condition’ Sentra and $6,000 for a ‘poor condition’ Sentra. If each type could be identified with certainty, a ‘great condition’ Sentra would sell for $12,000 and a ‘poor condition’ Sentra would sell for $6,000. A Nissan owner knows perfectly well whether his car is in great condition or poor condition. Potential buyers don’t, and the owner of a ‘poor condition’ car has no incentive to disclose the truth. Suppose, however, that buyers know the proportion of ‘great condition’ and ‘poor condition’ cars in the population.

a) What is the minimum proportion of ‘great condition’ cars that would induce all buyers and sellers to want to make a trade?

b) There would be no ‘great condition’ cars traded in the market if the proportion of this type of car is less than _______ in the population.

Answer 1