1. AKERLOF'S LEMONS: Used cars (UC) vary in quality, but potential buyers cannot tell them apart; it is hard to tell whether one has been well maintained with regular visits to a mechanic or driven like a robbery getaway car! Suppose potential buyers are willing to pay 24 for a high-quality UC but only 12 for a low-quality UC. The supply of high-quality UC is Q# = P# – 7 and the supply of low-quality UC is Q' = 2PL – 5. If you believe Pr[UC is of high quality] = 1/3 then what is your WTP for a used car of unknown quality? Remember that when you look at a used car, you cannot determine its quality, so you must rely on the probabilities. b. If the price you found in part (a) is offered, find the actual Q', Q#, and the probability that a given used car is high quality. Predict what happens in this market as the true Pr[UC is H] becomes known. HINT: Do the math and ponder the lesson of Akerlof's Lemons. а. с.

1. AKERLOF'S LEMONS: Used cars (UC) vary in quality, but potential buyers cannot tell them apart; it is hard to tell whether one has been well maintained with regular visits to a mechanic or driven like a robbery getaway car! Suppose potential buyers are willing to pay 24 for a high-quality UC but only 12 for a low-quality UC. The supply of high-quality UC is Q# = P# – 7 and the supply of low-quality UC is Q' = 2PL – 5. If you believe Pr[UC is of high quality] = 1/3 then what is your WTP for a used car of unknown quality? Remember that when you look at a used car, you cannot determine its quality, so you must rely on the probabilities. b. If the price you found in part (a) is offered, find the actual Q', Q#, and the probability that a given used car is high quality. Predict what happens in this market as the true Pr[UC is H] becomes known. HINT: Do the math and ponder the lesson of Akerlof's Lemons. а. с.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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