Question

In: Economics

In a used car market- Quality Poor (lemon) Fair Good Excellent % cars in quality 25%...

In a used car market-

Quality Poor (lemon) Fair Good Excellent
% cars in quality 25% 25% 25% 25%
Seller valuation $2,000 4,000 6,000 8,000
Buyer Valuation $4,000 6,000 8,000 10,000

Buyer does not know quality car when making offer/ competition among buyers/ buyers and sellers know probability distribution of types of cars

What price would a buyer offer a seller and what quality of car would be sold at price?

Solutions

Expert Solution

The expected value of buyer's offer = (0.25 * 4,000) + (0.25 * 6,000) + (0.25 * 8,000) + (0.25 * 10,000)

                                                         = 1,000 + 1,500 + 2,000 + 2,500

                                                         = $7,500

At a price of $7,500, good quality of car would be sold. Because for good quality cars buyer valuation is $8,000 and seller valuation is $6,000. So, at price of $7,500, seller will be willing to sell and buyer will be willing buy good quality cars.


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