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Unformatted text preview: s of cars should be sold in the market. This will occur if quality were observable to buyers 23 Adverse Selection (cont.) Buyers will estimate the quality of any car offered to be the average quality of the cars in the market
Buyer’s perceived quality, and therefore the price that they are willing to pay for any given car, is E(V) = (Vg + Vb)/2
What types of cars will be offered in the market?
Seller of a bad car: His car is worth VB < (Vg + Vb)/2. Thus, he will happily sell his car for more than it is worth.
Seller of a good car: His car is worth VB > (Vg + Vb)/2. Thus, he will refuse to sell his car for less than it is worth.
Since all cars are priced equally, only bad cars are offered In fact, buyers will actually anticipate this, and E(V) = V B. So only bad cars will be sold, and buyers will pay a fair price.
Inefficient outcome: good cars are not sold in the market! The market collapses through adverse selection.
24 Signaling Sellers of high quality cars would like to signal that their cars are higher...
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This document was uploaded on 03/09/2014 for the course COMM 371 at The University of British Columbia.
- Spring '13