Question

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?

Answer 1

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.