Suppose that there are three types of used cars good ones, medium ones and bad ones - and that sellers know which type of car they have. Buyers do not know which type of car a seller has, and sellers of good and medium cars have no way of proving what kind of car they have. Buyers know that the fraction of used cars in the total population of used cars that are good quality is 1/4, the fraction of used cars that are medium quality is 1/2, and the fraction of used cars that are bad quality is 1/4 (but as is typical in these situations, it is not necessarily the case that all the owners of these used cars will choose to sell them). The following table summarizes the values of the different cars for sellers and buyers in thousands of dollars Value for Value for Value for good car medium bad car car buyer seller 30 10 4 13 9. We assume that buyers are risk-neutral; that is, they are willing to pay their expected value of a car. (a) Is there a self fulfilling expectations equilibrium in which all kinds of cars are sold (bad, medium and good quality)? Explain briefly. (b) Is there a self fulfilling expectations equilibrium in which only bad and medium quality cars are sold? Explain briefly. (c) Is there a self fulfilling expectations equilibrium in which only bad cars are sold? Explain briefly.
Suppose that there are three types of used cars good ones, medium ones and bad ones - and that sellers know which type of car they have. Buyers do not know which type of car a seller has, and sellers of good and medium cars have no way of proving what kind of car they have. Buyers know that the fraction of used cars in the total population of used cars that are good quality is 1/4, the fraction of used cars that are medium quality is 1/2, and the fraction of used cars that are bad quality is 1/4 (but as is typical in these situations, it is not necessarily the case that all the owners of these used cars will choose to sell them). The following table summarizes the values of the different cars for sellers and buyers in thousands of dollars Value for Value for Value for good car medium bad car car buyer seller 30 10 4 13 9. We assume that buyers are risk-neutral; that is, they are willing to pay their expected value of a car. (a) Is there a self fulfilling expectations equilibrium in which all kinds of cars are sold (bad, medium and good quality)? Explain briefly. (b) Is there a self fulfilling expectations equilibrium in which only bad and medium quality cars are sold? Explain briefly. (c) Is there a self fulfilling expectations equilibrium in which only bad cars are sold? Explain briefly.
Chapter8: Market Failure
Section: Chapter Questions
Problem 10P
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Transcribed Image Text:good ones,
and that sellers know which type of car they have. Buyers do
not know which type of car a seller has, and sellers of good and medium cars have no way
Suppose that there are three types of used cars
medium ones and bad ones
of proving what kind of car they have.
Buyers know that the fraction of used cars in the total population of used cars that
are good quality is 1/4, the fraction of used cars that are medium quality is 1/2, and the
fraction of used cars that are bad quality is 1/4 (but as is typical in these situations, it is
not necessarily the case that all the owners of these used cars will choose to sell them). The
following table summarizes the values of the different cars for sellers and buyers in thousands
of dollars
for Value
medium
Value
for Value
for
good car
bad car
car
buyer
seller
30
10
13
We assume that buyers are risk-neutral; that is, they are willing to pay their expected value
of a car.
(a) Is there a self fulfilling expectations equilibrium in which all kinds of cars are sold
(bad, medium and good quality)? Explain briefly.
(b) Is there a self fulfilling expectations equilibrium in which only bad and medium
quality cars are sold? Explain briefly.
(c) Is there a self fulfilling expectations equilibrium in which only bad cars are sold?
Explain briefly.
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