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4. Suppose that half of the used cars offered for sale are reliable and half are unreliable. If potential buyers are willing to pay $6,000 for a reliable car, but only $3,000 for an unreliable one, how much will buyers offer for a car?

a. $2,500

b. $3,750

c. $4,500

d. $4,999 

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Raushan Raj
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2 Nov 2020

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Related questions

17. A risk-neutral consumer is deciding whether to purchase a homogeneous product from one of two firms. One firm produces an unreliable product and the other a reliable product. At the time of the sale, the consumer is unable to distinguish between the two firms' products. From the consumer's perspective, there is an equal chance that a given firm's product is reliable or unreliable. The maximum amount this consumer will pay for an unreliable product is $0, while she will pay $120 for a reliable product.

a. Given this uncertainty, what is the most this consumer will pay to purchase one unit of this product?

b. How much will this consumer be willing to pay for the product if the firm offering the reliable product includes a warranty that will protect the consumer?

Ā 

Ā 

Used car dealers are faced with the following problem. There are two types of used cars: gems and lemons. Buyers are willing to pay $8,000 for gems and $5,000 for lemons. Sellers of lemons want $3,000, while the sellers of gems want a minimum price of $6,000. Half of the cars offered for sale are gems and half are lemons. The sellers know which cars are gems and which are lemons, but the buyers and the dealer do not.

a) Assuming that neither the dealer nor the buyers of used cars can tell a gem or lemon apart, what will gems sell for in the used car market? What will lemons sell for? (You may ignore any costs of operating the used car business beside the costs of cars offered for resale).

b) A test is developed that flawlessly tells a gem from a lemon. The test, which costs nothing, is widely known. Any owner can run the test (though buyers cannot). An owner can easily offer to sell his car enclosing a certified copy of the test. The certification is an infallible sign of whether the car is a gem or a lemon. Assuming that every auto seller provides the test, what would then be the price for gems and lemons?

c) Assume now that the test costs $50. What will happen to the price of gems and lemons?

5. When uninformed buyers of used cars are willing to pay a price that is the average of the value of a lemon and the value of a good used car, which of the following will occur?

a. Most used cars offered for sale will not be lemons.

b. Most used cars offered for sale will be lemons.

c. The quantity supplied of lemons will be identical to the quantity supplied of good used cars.

d. Only good used cars will be offered for sale. 

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