Answered: Suppose the equilibrium price for good…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Suppose the equilibrium price for good quality used cars is $20,000. And the equilibrium price for poor quality used cars is $10,000. Assume a potential used car buyer has imperfect information as to the condition of any given used car. Assume this potential buyer believes the probability a given used car is good quality is .60 and the probability a given used car is low quality is .40. Assume the seller has perfect information on all cars in inventory.

How does the informational imbalance result in adverse selection?

a. The expectedprice offered by the buyer encourages the seller to sell a poor quality car. Hence only poor quality cars are sold, which harms sellers.

b. The expected price offered by the buyer encourages the seller to sell a good quality car. Hence only good quality cars are sold, which harms buyers.

c. The expected price offered by the buyer encourages the seller to sell a good quality car. Hence only good quality cars are sold, which harms sellers.

d. The expected price offered by the buyer encourages the seller to sell a poor quality car. Hence only poor quality cars are sold, which harms buyers.

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