Consider a financial market with two assets: peaches and lemons. The fraction of lemons in the economy is λ = 0.4. Buyers value peaches at up = $20 and lemons at v = $10. Sellers value peaches at vs = $16 and lemons at vi = $8. Sellers have all the bargaining power when setting prices at which assets trade. a) Assume both buyer and sellers can perfectly observe the quality of assets in the market. At what price will lemons and peaches trade? b) Now assume that the quality of assets is unobservable, but that buyers and sellers have symmetric information. That is, neither sellers or buyers can tell whether a particular asset is a lemon or a peach. What is the (pooling) price P* at which assets trade? c) Now assume that only sellers can observe the quality of assets, so that there is asym- metric information between buyers and sellers. Explain (intuitively, without equations) why the quality of assets traded in equilibrium will now depend on the price

Consider a financial market with two assets: peaches and lemons. The fraction of lemons in the economy is λ = 0.4. Buyers value peaches at up = $20 and lemons at v = $10. Sellers value peaches at vs = $16 and lemons at vi = $8. Sellers have all the bargaining power when setting prices at which assets trade. a) Assume both buyer and sellers can perfectly observe the quality of assets in the market. At what price will lemons and peaches trade? b) Now assume that the quality of assets is unobservable, but that buyers and sellers have symmetric information. That is, neither sellers or buyers can tell whether a particular asset is a lemon or a peach. What is the (pooling) price P* at which assets trade? c) Now assume that only sellers can observe the quality of assets, so that there is asym- metric information between buyers and sellers. Explain (intuitively, without equations) why the quality of assets traded in equilibrium will now depend on the price

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

See similar textbooks

Related questions

Q: Consider an exchange economy with two goods, 200 agents of type A, and 100 agents of type B. The…

A: For type A : Ua = ( x1)0.5 Number of agents = 200 Endowment per agent = (10 , 20 ) Budget…

Q: 7.10. SALE OF BUSINESS. Suppose that a firm owns a business unit that it wants to sell. Potential…

A: This problem can be approached using the concept of expected value. The buyer's expected gain from…

Q: For the following problem, round your calculations to the nearest two decimals. In an exchange…

A: Equilibrium: A situation or circumstance in which economic forces are balanced is referred to as…

Q: 6. An analyst is assessing a DM's utility function for profit Y, in dollars, ranging from -400,000…

A: Expected utility is a tool that helps to analyze situations in which there is a possibility number…

Q: Consider an exchange economy with two agents (i = a, b) and two goods (j = 1,2) with the following…

A: A rectangular diagram showing a combination of two goods and two individuals in a closed economy is…

Q: 1) Consider a market in which some high-quality goods are sold, but not as many as if there was…

A: A market is a location for buyers and sellers to interact with each other and trade the goods. The…

Q: In an exchange economy, there are two agents, A and B, and there are 320.00 total units of x and…

Q: Suppose you have just inherited $10,500 and are considering different options for investing the…

A: Expected rate of return: It is the good outcome as well as the bad outcome that the investor expects…

Q: Eishe, a mortgage broker, is arranging a mortgage for her client Yasmine. Eishe's recommendation is…

A: Eishe, a mortgage broker, is arranging a mortgage for her client Yasmine. Eishe's recommendation is…

Q: 1. Morris Zapp and Philip Swallow consume coffee (c) and tea (t). Morris has an initial endowment of…

A: EXPLANATION

Q: Suppose you are considering buying $5,000 worth of Canada savings bonds (risk-free) and a portfolio…

A: In economics, a risk-free asset is an investment with a guaranteed return. These assets are…

Q: Consider the perceived value of getting $100 today. In the table below, indicate how valuable $100…

A: To address this question, we need to understand that the perceived value of money can change over…

Q: **Practice** suppose that many insurance companies sell contracts of the following format:- The…

A: e. None of the options aboveExplanation:To find the actuarially fair premium, we need to calculate…

Q: 2. Now suppose there is no financial intermediary to handle liquidity shocks. However, at t= 1 a…

A: Consumer's optimum decision at t = 0 (IM): At t = 0, consumers can either invest their wealth in the…

Q: Determine whether widgets are a normal or inferior good, and whether widgets and wodgets are…

A: A good is said to be normal or inferior good depending on how does the quantity demanded of the good…

Q: (f) The price of Stock Y, which is currently $80, can go to $120, $90, or $60 in 6 months' time.…

A: Price of Y after 6 months Probability $120 P1 $90 P2 $60 P3 P1+P2+P3 = 1 (Law of total…

Q: If an offer is silent as to the proper means of acceptance, then any reasonable means of acceptance…

A: Silence:- If indeed the proposer conveys this to the recipient and the recipient acknowledges the…

Q: **Practice** suppose that many insurance companies sell contracts of the following format: - The…

A: Please refer below for detailed explanations of the above question.Explanation:Step 1: 1: Answer A.…

Q: A seller has an indivisible asset to sell. Her reservation value for the asset is s, which she knows…

A: As per the guideline, answer has been provided to Question1. Please post the remaining question…

Q: In equilibrium _______ XBOX units will be traded, each at a price of _____ . Question 6 options:…

A: Equilibrium refers to a state where the market forces of demand and supply are equal.

Q: Which is NOT true about the weak, semi-strong, and strong forms of the efficient markets? Under the…

A: Any economic assets calculated in cash that companies and enterprises utilize to purchase the…

Q: An insurance company sells policies for $1,000 each. Based on historical data, an average of 1 in…

A: Expected pay out (EP) can be calculated by using the following formula.

Q: The winning bid for a house at a bank auction was $10. But the house was not in good condition.…

A: Economics refers to the social science that studies the production, distribution, and consumption of…

Q: In economics, an index of risk aversion is defined as: I(m) = -U" (m) U'(m) where m measures how…

A: Index of Risk Aversion: I(m) =-U''(m)U'(m) Risk-averse individuals are people who hate risk and want…

Q: For the following problem, round your calculations to the nearest two decimals. In an exchange…

A: Answer: Given, The utility function of A: uAx,y=x2y The utility function of B: uBx,y=xy Initial…

Q: One method of solving this problem is through signaling. Signaling is a strategy one uses when they…

A: Signaling occurs when there is asymmetric information within an economy this means that there is a…

Q: What is the concensus of how economists believe the government should deal with occurences of moral…

A: Numerous market inefficiencies, unethical practises, and a lack of transparency in the financial…

Q: In circumstances of imperfect information should one expect the market to be efficient? Explain…

A: imperfect information occurs where the information is not perfect. The asymmetric information is…

Q: efficiency are INCORRECT? i) Strong-form efficiency implies that fundamental analysis (such as…

A: Strong form efficiency is considered to be the most stringent version which in turn states that all…

Question

Consider a financial market with two assets: peaches and lemons. The fraction of lemons
in the economy is λ = 0.4. Buyers value peaches at up = $20 and lemons at v= $10.
Sellers value peaches at vs = $16 and lemons at vi = $8. Sellers have all the bargaining
power when setting prices at which assets trade.
a) Assume both buyer and sellers can perfectly observe the quality of assets in the
market. At what price will lemons and peaches trade?
b) Now assume that the quality of assets is unobservable, but that buyers and sellers
have symmetric information. That is, neither sellers or buyers can tell whether a particular
asset is a lemon or a peach. What is the (pooling) price P* at which assets trade?
c) Now assume that only sellers can observe the quality of assets, so that there is asym-
metric information between buyers and sellers. Explain (intuitively, without equations)
why the quality of assets traded in equilibrium will now depend on the price.
d) Calculate the share of lemons that trade in the market as a function of the price, and
buyers' expected valuation for the asset as a function of the price. Show that the pooling
price P* clears the market.
e) Assume the fraction of lemons increases to λ = 0.5. Show that the pooling price P*
no longer clears the market. Calculate the new equilibrium price. Comment.

Expert Solution

This question has been solved!

Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.

This is a popular solution!

SEE SOLUTION Check out a sample Q&A here

Step 1: Introduction

VIEW

Step 2: Sellers value

VIEW

Step 3: a) Perfectly Observable Quality:

VIEW

Step 4: b) Unobservable quality with symmetric information:

VIEW

Step 5: c) Asymmetric information, where quality is observed only by sellers:

VIEW

Solution

VIEW

Trending now

This is a popular solution!

Step by step

Solved in 6 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.

Similar questions

1a) I have a budget of 10 million. I want to buy a house and some cars (x) to fill up my garage. The size of the house is measured in squared metres with a price of 1000 per square metre (y). My utitility follows a quaslinear function, u(x,y) = 2√x + 2y. What are the demand functions for the number of cars and the land coverage of my house? 1b) If a land tax of 10% per square metre is implemented, what is the income effect? What is the substitutiion effect?
1) A key difficulty facing insurance companies is that people know more about their health than do insurance companies, and that those people who are seriously ill are the most likely to want to obtain health insurance. What is this phenomenon called? A) moral hazard B) economic irrationality C) asymmetric information D) adverse selection 2) An insurance company is likely to attract customers like Clancy who want to purchase insurance because he knows better that the company that he is more likely to make a claim on a policy. What is the term used to describe the situation above? A) moral hazard B) adverse selection C) asymmetric information D) economic irrationality 3) The term that is used to refer to a situation in which one party to an economic transaction has less information than the other party is A) inefficient market hypothesis. B) moral hazard. C) information disparity. D) asymmetric information. 4) Which of the following parties is…
Can someone please help? Thank you.
Suppose you get two job offers when you graduate. First offer is in LA and pays $6000 permonth. The price of food in LA is $3 and price of housing is $5. The second offer is in SanFrancisco and pays $10000. Both food and housing is more expensive in SF at PF = 4 and PH = 6respectively. If your utility function is U (F, H) = F1/4 H 3/4 which job offer should you accept?
8. Suppose that the world can be described using two states and two stocks Yand 2 are available. We assume the stocks' future prices have the following distribution State Future Prices Stock Y Future Prices Stock Z $10 $20 $15 $11 1 The initial prices for the stocks are: Y(1) = $13, Z(1) = $10. Our utility function in (w1, w2) space is U(w1, w2) = w1 X w2, where U represents the utility level. Now we have an initial endowment of $420. How many shares and what positions of Y and Z should we choose to build our portfolio so that we actually maximize our utility function? (Assume fractional shares are permitted.) %3D Whot oMO
Tyler buys a futures contract from Alex that gives him the right to buy 1,000 barrels of oil at $125 per barrel in 48 months. What happens in 48 months if the actual price per barrel of oil is $100? A.) Tyler must pay Alex $25,000. B.) Tyler makes a profit of $25 per barrel, or $25,000. C.) The contract becomes void because the price turned out lower than expected. D.) Alex must give Tyler $10,000.
(1) Consider a small exchange economy with two consumers, A and B, and two commodities, ₁ and 2. Consumer A's initial endowment is 3 units of ₁ and 2 unit of 2. Consumer B's initial endowment has 5 units of 2₁ and 4 units of r2. Consumer A's utility function is given by U(₁, ₁) = x^x^. Consumer B's utility function is given by U(x,x) = 2x² + x2. Note that and are the amounts of the two goods for Consumer A, and rf and are amounts of the two goods for Consumer B. (a) Draw an Edgeworth box, showing the initial allocation. Label it as E. Measure Consumer A's consumption from the lower left and Consumer B's from the upper right. Also measure the number of ₁ on the horizontal axis and the number of r2 on the vertical axis. (b) Draw Consumer A's indifference curve (ICA) going through E. (c) Draw Consumer B's indifference curve (ICB) going through E.
Two restaurants are on the same block. One has been opened for 10 years and is a thriving business. The other one has been open for only a year. They both want to expand. When the two owners go to the local bank looking for a loan, which one is likely to get a lower interest rate? Explain in terms of the risk-return principle.
20) This decision tree represents the expected profits and the standard deviations associated with three decisions facing a mobile phone producer (All figures are in millions of dollars). The root node (the one on the left) represents the decision of whether to produce the phones in China or North America. The second pair of nodes represent the decision of whether to market the phones in China or North America; and the final nodes represent the choice of selling price: if the phones are sold in China, they will be sold for either $30 or $40, whereas if they are sold in North America, they will be sold for either $40 or $50. Based on the calculated values, what is the company's best strategy? Mean $30 1.250, sd 750 Sell China $40 Mean 375, sd = 625 Make in China Mean= -1,000, sd = 1,500 $40 Sell NA S50 Mean =-1,500, sd = 1,250 Sell China $30 $40 Make in NA Mean 1,250, sd.- 2,137 Sell NA $40 S50 Mean --250, sd-1.639
Van believes that housing prices are likely to rise rapidly in the near future and wants to profit by investing in real estate. He is considering buying individual properties, but he has little practical knowledge of real estate. A friend suggests that he buy the real estate sector, because this type of investment vehicle offers diversification within a particular sector.