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home1 - a car on the market(c Which of these equilibria is...

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Homework 1 1. Suppose that the quality of used cars has the following distribution: 10% has the high quality q = 1, 80% have the medium quality q = 0 . 6, and 10% have the low quality q = 0. Suppose that the seller of each car knows the quality q and is willing to sell as long as the price is at least $10000 · q . There are also many potential sellers (many more than buyers). Each buyer is willing to pay at most $15000 · ¯ q when she expects the quality of the car offered for sale to be ¯ q on average. (a) Describe the market equilibrium if buyers can observe the quality of each car. (b) Describe the market equilibria if buyers know only the average quality of
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Unformatted text preview: a car on the market. (c) Which of these equilibria is the most beneficial for the society? It it fully efficient? Why? (d) Explain why arbitrage may be a problem. 2. Suppose that each seller may offer a warranty that costs him 0 if the car has the high quality, and costs 5000 if not. (a) Describe the market equilibrium where all cars are sold: the high-quality cars are sold with a warranty, and others without a warranty, but at a lower price. (b) What other mechanisms, besides warranty, are likely to reduce adverse selection in the market for used cars? 3. Problem 1 on p.272 in the textbook....
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