Question

1. In markets with asymmetric information or hidden information, consumer protection laws ("lemon laws") increase sales of high-quality goods because:

A. They prohibit anyone from selling a lemon

B. No one will sell a lemon for fear of being fined or imprisoned

C. Sellers have far less incentive to exaggerate a good's quality, because buyers will often return lemons that were advertised as high quality

D. They require sellers to sell both high- and low-quality goods

2. The seller of a used house claims that it is structurally sound and that the heating and air conditioning systems are in good shape. He offers a one-year warranty on the house in which he agrees to repair any defects found during this time. A potential buyer should expect these statements to be:
		A.  Truthful, because offering a warranty would be expensive if the house were defective B.  An exaggeration, because the seller has an incentive to lie to get a high price C.  Truthful, because home sellers are generally honest people D.  Not credible, because otherwise, why would the seller offer the warranty?

Answer 1

1. The correct answer is C

In markets with asymmetric information or hidden information, consumer protection laws increase sales of high-quality goods because Sellers have far less incentive to exaggerate a good's quality, because buyers will often return lemons that were advertised as high quality.

This is because when in case of hidden information, the seller knows that not all the information is going to get to the buyer, so he has less incentive to exaggerate the quality of a good. Consumer protection laws allows the buyers to return the product if found to be exaggerated advertised lemons.

2. The correct answer is A

The seller of a used house claims that it is structurally sound and that the heating and air conditioning systems are in good shape. He offers a one-year warranty on the house in which he agrees to repair any defects found during this time. A potential buyer should expect these statements to be Truthful, because offering a warranty would be expensive if the house were defective.

This is because this is the rational choice. A seller would never offer a warranty if his house had not been sound. He’s offering it just to make buyer sure of his sayings. And if he’s offering the warranty, it means his house is perfectly sound and can be effectively sold.