H10TradingRights - 36 Asymmetric Information Adverse...

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1 Situations in which some market participants know more about the value of the good than others. Asymmetric information causes: Inefficient market outcomes Market breakdown Asymmetric Information Asymmetric Information Adverse Selection – unobservable characteristic 36 3/4 used cars are “good” (“peach”) 1/4 used cars are “bad” (“lemon”) Everyone knows: The Lemons Problem Knowledge Seller knows: Quality of the car he is selling 100 buyers of used cars 100 sellers of used cars Market Participants Buyers: Cannot distinguish between good and bad cars Asymmetric Information Asymmetric Information Value lemon Value peach Seller Buyer $1000 $1200 $2000 $2400 36 All cars sell for $2100 Can good and bad cars sell for the same price? Buyer’s benefit is ¼ ·1200 + ¾ ·2400 probability lemon probability peach Asymmetric Information The Lemons Problem Value lemon Value peach Seller Buyer $1000 $1200 $2000 $2400 ¼ ¾ = 2100 36 NO
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2 Sellers don’t sell good cars
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H10TradingRights - 36 Asymmetric Information Adverse...

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