Suppose that you own a used car dealership. You want to sell a 2005 Honda Civic LX. You know that this car is of high quality, and it cost you $5000 to acquire it (so you will not sell it at a price below $5000). However, consumers cannot see the quality of the car at the time of purchase. They believe that 25% of the cars in the used car market are high-quality cars and 75% are low-quality cars or “lemons.” A typical lemon costs $2000 to acquire (so you will not sell it at a price below $2000). Consumers are eager to buy and are willing to pay up to $3000 for a lemon and $6000 for a high-quality car. (a) Suppose for a moment that buyers could observe the quality of your car at the time of purchase. At what price would you be able to sell the 2005 Honda Civic Accord LX? If you had a lemon instead, what price would it sell at? (Suppose as a dealer you can induce buyers to pay at their highest willingness to pay. Keep this assumption in all of the following questions.) From now on, suppose that only you (the seller) know the quality of the cars. (Buyers do not know the quality, but know the proportion of high- and low-quality cars in the market). (b) Will you be able to sell your 2005 Honda Civic Accord LX? Explain (c) What sort of asymmetric information is this an example of? What are its consequences for the market outcome?
Suppose that you own a used car dealership. You want to sell a 2005 Honda Civic LX. You know that this car is of high quality, and it cost you $5000 to acquire it (so you will not sell it at a price below $5000). However, consumers cannot see the quality of the car at the time of purchase. They believe that 25% of the cars in the used car market are high-quality cars and 75% are low-quality cars or “lemons.” A typical lemon costs $2000 to acquire (so you will not sell it at a price below $2000).
Consumers are eager to buy and are willing to pay up to $3000 for a lemon and $6000 for a high-quality car.
(a) Suppose for a moment that buyers could observe the quality of your car at the time of purchase. At what price would you be able to sell the 2005 Honda Civic Accord LX? If you had a lemon instead, what price would it sell at? (Suppose as a dealer you can induce buyers to pay at their highest willingness to pay. Keep this assumption in all of the following questions.)
From now on, suppose that only you (the seller) know the quality of the cars. (Buyers do not know the quality, but know the proportion of high- and low-quality cars in the market).
(b) Will you be able to sell your 2005 Honda Civic Accord LX? Explain
(c) What sort of asymmetric information is this an example of? What are its consequences for the market outcome?
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