final - Final Exam 109 You have two hours to solve three...

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Final Exam 109 You have two hours to solve three problems. Good luck! 1. Suppose that 10% of used cars have the high quality q = 1, 70% have the medium quality q = 0 . 5, and 20% have the low quality q = 0. The seller of each car knows the quality q and is willing to sell as long as the price is at least $8000 · q . Sellers compete aggressively on the price. A buyer who expects the average quality ¯ q is willing to pay at most $10000 · ¯ q . (a) Describe what happens in this market if buyers know the exact quality of each car. Is this an efficient outcome? (b) Find all the market equilibria in the asymmetric information case when the buyers do not know the q of each car exactly. (c) Which equilibrium under asymmetric information is the best in terms of welfare? Is it fully efficient? What happens to this equilibrium if buyers can resell “lemons”? (d) Describe market mechanisms that can reduce adverse selection and improve efficiency.
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