2. Suppose one in every four new personal computers is defective. The defective ones, however, cannot...

2. Suppose one in every four new personal computers is defective. The defective ones, however, cannot be identified except by those who own them. Consumers are risk neutral and value nondefective at $2000 each. Computers do not depreciated physically with use. If used computers sell for $600, how much do new ones sell for?

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Expert Solution

It has been provided that one in every four new personal computers is defective.

This means probability of defective new personal computer is (1/4) 0.25 and the probability of non-defective new personal computer is (3/4) 0.75.

The lemon principle applicable to the trade of used goods indicate that all the computers sold in the second hand market would have some defect.

So, the price of used computer reflects the price of defective new personal computer.

The price of used computer is $600.

So,

The price of defective new personal computer is also $600.

The price of non-defective new personal computer is $2,000.

Calculate the price of new computer -

Price of new computer = [Price of defective new personal computer * probability of defective new personal computer] + [Price of non-defective new personal computer * probability of non-defective new personal computer]

Price of new computer = [$600 * 0.25] + [$2,000 * 0.75] = $150 + $1,500 = $1,650

The Price of new computer is $1,650.

Rahul Sunny answered 1 year ago

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