Econ+395+Final+Exam+Fall+2008+-+Bonus+Question - lawnmowers...

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Economics 395 Topics in Risk and Uncertainty Final Examination Fall 2008 Bonus Question Name:____________________________________ UMID:_______________
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Bonus Question (a) What does the term “adverse selection” mean? Feel free to use clear but simple examples to help explain. Consider a simple environment where agents try to sell used lawnmowers. These used lawnmowers vary in quality, and the lawnmower’s quality is well know to its current owner. High quality lawnmowers are worth $300 to a buyer, whereas low quality lawnmowers are worth only $100 to a buyer. The owners of the lawnmowers have reservation prices of $250 for the high quality mower and $75 for the low quality mower. (b) If there are 100 high quality lawnmowers available and 100 low quality lawnmowers available, and if there are 80 buyers currently searching for a mower, describe the most efficient pattern of trade. (c) If lawnmower owners are unable credibly to establish the true quality of their
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Unformatted text preview: lawnmowers, do you think that the efficient outcome can be attained in equilibrium? Explain your answer. (d) What opportunities could you introduce into this simple environment that would allow lawnmower owners to establish the quality of their lawnmowers? (e) In the insurance market model, we know that a separating equilibrium often exists. A separating equilibrium involves giving the agents a choice between alternative contracts, knowing that different types of agents will choose different contracts. In other words, by choosing the “right” contract, an agent can credibly establish his or her private information to the insurance seller. Explain how the insurance market model provides the low-risk buyers the chance to establish themselves credibly, but the lemon’s market did not. What is fundamentally different between the types of decisions that the privately informed agents are making in the two scenarios?...
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This note was uploaded on 04/13/2010 for the course ECON 330 taught by Professor Minetti during the Fall '08 term at Michigan State University.

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Econ+395+Final+Exam+Fall+2008+-+Bonus+Question - lawnmowers...

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