Solutions to End-of-Chapter Exercises
Chapter 14 [29]
Section 14.1 [29.1]: The Lemons Problem
1.1
buyers, sellers
1.2
2,500
1.3
Equilibrium:
no,
yes,
no
Price change:
drop,
--
rise
1.4
less than
1.5
arrow up, arrow up
1.6
1, 4
1.7
a.
In Sourland, the minimum supply price for plums exceeds the willingness to pay for a
lemon ($2,000), so in equilibrium, only lemons are in the market.
In Sweetland, the
minimum supply price for plums is less than the willingness to pay for a lemon ($2,000),
so in equilibrium, the market is thin, with 1/5 of cars being plums and 4/5 of cars being
lemons.
The expected value of a used car = $2,600 = (4/5) $2,000 + (1/5) $5,000
b. Consumers in Sourland expect all lemons, while consumers in Sweetland expect only
20% of used cars to be lemons.
1.8
For P cars, we have the normal adverse-selection problem.
If the minimum supply price
for plums exceeds the willingness to pay for a lemon ($1,000), the equilibrium price is
$1,000 and only lemons are in the market.
For F cars, the supply of both lemons and plums is perfectly inelastic with respect to
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