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Solution1. Consider the market for used cars shown in the figure below. The top panel (a) shows the market for low-quality cars (lemons); the bottom panel (b) shows the market for high-quality cars (plums). If all buy-ers and sellers had full information about the quality of automobiles being offered for sale, lemons would sell for $8,000 and plums would sell for $16,000.Price($/car)S(a) LemonsD600$8,000Price($/car)S(b) PlumsD600$16,0004,000a. Suppose that buyers recognize that the chance of getting a lemon is 50%, but are unable to tell whether a car is a lemon or a plum. What is the expected value of a used car to a buyer?b. If the market works to the extent that prices reflect the expected value of a used car, how many high-quality automobiles will be offered for sale at the price determined in (a)? How many low-quality automobiles will be offered for sale? Of the automobiles offered for sale, what is the proportion of low-quality automobiles?c. Compared to a market with perfect information, what kind of deadweight loss does the information loss generate in the market for high-quality used cars? Is there a deadweight loss in the market for lemons, too?0Quantity ofused cars2,0000Quantity ofused cars200.. 2. In Problem 1, we discovered that imperfect information about the quality of used cars caused fewer plums and more lemons to be offered for sale. Thinking in discrete steps,a. How does this revision of the expected value affect the proportion of lemons to plums offered for sale by sellers?Asymmetric Information15Goolsbee1e_Solutions_Manual_Ch15.indd 209Goolsbee1e_Solutions_Manual_Ch15.indd 20911/15/12 3:10 PM11/15/12 3:10 PM
210Part 4 Beyond the BasicsSolutionSolution
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used car, Information asymmetry, Adverse selection, high-quality cars