Adverse selection occurs in the used car market because: Question 17 options: A) the seller has...

Adverse selection occurs in the used car market because:

Question 17 options:

A)	the seller has more information than the buyer.

B)	both the buyer and the seller have incomplete information.

C)	the buyer has more information than the seller.

D)	Any of these could be the cause of adverse selection in the used car market.

Solutions

Expert Solution

Asymmetric information is a situation where the buyer usually do not have any information about the quality of the good being traded in the market. In the case of "Used Car Market", only sellers of the cars know if their car is a Lemon ( bad quality car) or a Peach ( good quality car).

When the buyers do not have any information if the car is a peach or a lemon, they are willing to pay a fixed price which is the average of price for a peach and the price of a lemon. Since the price of peach is more than the average price, the sellers of peaches exit the market at a lower price . As a result, at the average price, only sellers of lemons are willing to sell their cars. Consequently, the average quality of cars in the Used Car Market decreases. Those buying cars in the Used Car Market usually end up buying a Lemon. This problem is called Adverse Selection which arose due to asymmetric information where the buyers do not have the information about the quality of cars.

Thus, the correct answer is

A) the seller has more information than the buyer

Rahul Sunny answered 2 years ago

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