This topic contains a solution. Click here to go to the answer

Author Question: The market for used cars is shown in the above figure. Buyers cannot tell whether any given car is a ... (Read 693 times)

jwb375

  • Hero Member
  • *****
  • Posts: 540


The market for used cars is shown in the above figure. Ten percent (10%) of all cars are lemons. A mechanic is offering to inspect a car for sale and certify that a car is not a lemon. If car sellers are risk neutral, what is the highest price that a car seller would pay for such a service? Who would buy this service?


Related Topics

Need homework help now?

Ask unlimited questions for free

Ask a Question

shailee

  • Sr. Member
  • ****
  • Posts: 392
Lemon owners would not buy this service because they know that their cars would not pass the inspection. Sellers of good cars would receive $1,900 for their cars if this service did not exist, and $2,000 for their cars with this service. Thus, each owner of a good car would pay no more than $100 for this service. All good car sellers would buy this service since not being certified signals that a car is a lemon.




shailee

  • Sr. Member
  • ****
  • Posts: 392

debasdf

  • Hero Member
  • *****
  • Posts: 570


The market for used cars is shown in the above figure. Buyers cannot tell whether any given car is a lemon. For all cars offered for sale to be sold, the percent of all cars that are lemons is θ. What happens to θ if car buyers incur a $100 transaction cost when buying a used car?



Juro

  • Sr. Member
  • ****
  • Posts: 337
The sellers of good cars have a reservation price of $1,800. Setting $1,800 equal to the expected value of a car yields 1800 = (θ ∗ 1,000) + ((1 - θ) ∗ 2,000) = 2,000 - (θ ∗ 1,000). So, θ = 20%. If a $100 transaction cost is incurred then set 1800 = (θ ∗ 1,000) + ((1 - θ) ∗ 2,000) - 100. This yields θ equals 10%. If buyers incur a transaction cost, their net expected value of a car purchase declines. The probability of a car being a lemon must decline to keep the price above the reservation price of sellers of good cars.



 

Did you know?

The human body produces and destroys 15 million blood cells every second.

Did you know?

Patients who cannot swallow may receive nutrition via a parenteral route—usually, a catheter is inserted through the chest into a large vein going into the heart.

Did you know?

Today, nearly 8 out of 10 pregnant women living with HIV (about 1.1 million), receive antiretrovirals.

Did you know?

When Gabriel Fahrenheit invented the first mercury thermometer, he called "zero degrees" the lowest temperature he was able to attain with a mixture of ice and salt. For the upper point of his scale, he used 96°, which he measured as normal human body temperature (we know it to be 98.6° today because of more accurate thermometers).

Did you know?

Though methadone is often used to treat dependency on other opioids, the drug itself can be abused. Crushing or snorting methadone can achieve the opiate "rush" desired by addicts. Improper use such as these can lead to a dangerous dependency on methadone. This drug now accounts for nearly one-third of opioid-related deaths.

For a complete list of videos, visit our video library