The first Harrys Cars sells high quality cars that it carefully inspects and if

The first harrys cars sells high quality cars that it

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The first, Harry's Cars, sells high-quality cars that it carefully inspects and if necessary, services. The second dealership, Lew's Motors, sells lower-quality cars. If consumers knew the quality of the used cars they were buying, they would gladly pay $12,000 on average for cars Harry sells, but only $9,000 on average for the cars Lew sells. Unfortunately, the dealerships are new and have not had time to establish reputations, so consumers don't know the quality of each dealership's cars. Consumers shopping at these dealerships figure that they have 50-50 chance of ending up with a high quality car, no matter which dealership they go to, and hence are willing to pay $10,500 on average for a car. Harry has an idea:it will offer a bumper-to-bumper warranty for all the cars it sells.He knows that a warranty lasting Y years will cost $500Y on average, and it also knows that if Lew tries to offer the same warranty, it will cost Lew $1,000Y on average. What's the cheapest warranty that Harry could offer to generate a credible signal of his car's quality, i.e. Lew will not match the offer. (Note: Y doesn't have to be an integer.)
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  • Spring '14
  • Economics, producer, Widgets, Economic equilibrium

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