Used car market, we have sellers who only sell good cars and sellers who sell lemons....

Used car market, we have sellers who only sell good cars and sellers who sell lemons.

Value	Seller	buyer
Good car	1500	2000
Lemon	600	400

If you are a good car dealer and successfully sold a good car, what is the profit?

Under symmetric information, will the lemon owner be able to make profits?

Under asymmetric information, the only information buyers have is there are 50% bad cars and 50% lemons in the market.

For a risk neutral buyer, what is the price they are willing to pay for a car? What is the price a risk averse buyer willing to pay?

Base the prices you just calculated, what is the profit for a good car dealer from selling one car?

What is the profit for a bad car dealer from selling a car?

Still under asymmetric information. Suppose good car sellers start to leave the market, now there are 10% good cars and 90% bad cars in the market.

For a risk neutral buyer, what is the price they are willing to pay for a car? What is the price a risk averse buyer willing to pay?

Base the prices you just calculated, what is the profit for a good car dealer from selling one car?

What is the profit for a bad car dealer from selling a car?

Under asymmetric information, what will happen eventually to this used car market?

Solutions

Expert Solution

1) The profit will be 500 if a good car dealer successfully sells a good car.

2)A lemon owner cannot make profits under symetric information since no buyer will pay more than 400.

3)The price risk averse buyers will be willing to pay is 1200.

The price risk neutral buyers will be willing to pay is 2000.

4)The profit for a bad car dealer is 1400.

The good car dealer will have a loss of 300 if they have to sell to a risk averse buyer and a profit of 500 if they sell to a risk neutral buyer.

5)Risk neutral buyers will still pay 2000.

The profit for a good car dealer in this case is 500

The profit for a bad car dealer is 1400 in this case.

Risk averse buyers will pay 560.

The loss for a good car dealer in this case is 940.

Even bad car dealers will face a loss of 40 while selling to risk averse buyers.

5)Under asymetric information, buyers often do not have the information to distinguish a lemon from a good car. Thus, sellers of good cars cannot get better-than-average market prices for their products. This will lead to good car sellers exiting the market further compunding the problem.

Rahul Sunny answered 1 year ago

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