Consider the market for used cars and let X = value of the car. Sellers know...

Consider the market for used cars and let X = value of the car. Sellers know the value of the car they sell and their utility is U(X) = X. Buyers only know that car value is uniformly distributed on (50,150) and their utility is 1.5×X. Suppose the posted price for used cars is 90. Will consumers buy a car at this price? Explain.

Expert Solution

Answer:-

a.) Adverse selection in used cars:

The used cars are sold on the basis of asymmetric information, where an adverse outcome of the exchange between the buyers and sellers happens. Therefore, it is termed as the market for lemons for used cars problem. In a market for used cars, the sellers will not be willing to sell a high average priced car for a low price. Likewise, the buyers will not be willing to pay a price which is more the average price. Therefore, when the car value is uniformly distributed, the average value of the car is.

Starting value of the car - Ending value of the car Average price = SE

=50+150

= 100

Therefore, the average price of the car is 100. Hence, the buyers will buy the car as the value of the car is below the average price.

Rahul Sunny answered 2 years ago

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