The lemon problem. Suppose that used cars may be either highquality or lemons. The buyers...

The lemon problem. Suppose that used cars may be either high quality or lemons. The buyers and sellers of lemons value them at $1,000 and $500 respectively. The buyers and sellers of high quality used cars value them at $5,000 and $3,500 respectively. Assume that sellers know the quality of their vehicle but buyers do not and cannot determine it. (a) If the proportion of lemons in the market is 10%, how much are buyers willing to pay for a used car? Does the used car market function? Why or why not? Does the proportion of lemons change?

Expert Solution

a)So, the proportion of lemons is 10%, so high-quality cars are 90%, so from the buyer's point of view, buyer values lemons at 1000 $ and high-quality cars at 5000 $, so 0.1*1000 +0.9*5000=>4600 $,

b) Yes , the used car market functions because the old car is at a cheaper rate, and people are willing to buy used cars provided they are quality used cars, the lemons proportion keeps changing because anybody can sell a used car and nobody checks all the parts of vehicle, the vehicle comprised of many parts and after certain years, these parts are mechanical and can go wrong.

Rahul Sunny answered 2 years ago

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