Suppose one in every ten new laptops is defective. The defective ones, however, cannot be identified...

Suppose one in every ten new laptops is defective. The defective ones, however, cannot be identified except by those who own them. Consumers are risk neutral and value non-defective laptops at $500 each. If used laptops sell for $100, how much do new ones sell for? Show your work. (Hint: Use the lemons principle.)

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Expert Solution

It has been provided that one in every ten new personal computers is defective.

This means probability of defective new personal computer is (1/10) 0.1 and the probability of non-defective new personal computer is (9/10) 0.9

The lemon principle applicable to the trade of used goods indicate that all the computers sold in the second hand market would have some defect.

So, the price of used computer reflects the price of defective new personal computer.

The price of used computer is $100

So,

The price of defective new personal computer is also $100.

The price of non-defective new personal computer is $500.

Calculate the price of new computer -

Price of new computer = [Price of defective new personal computer * probability of defective new personal computer] + [Price of non-defective new personal computer * probability of non-defective new personal computer]

Price of new computer = [$100 * 0.1] + [$500 * 0.9] = $10+$450=$460

The Price of new computer is $460

Rahul Sunny answered 1 year ago

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