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Asymmetry of information - Market for lemons

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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 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 products reliable or unreliable. The maximum amount this consumer will pay for an unreliable product is $0, while she will pay $50 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? Explain.

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Solution Summary

This problem calculates the price customers are willing to pay for a homogeneous product under asymmetry of information. The concept discussed here is market for lemons where there are two kinds of products in the market - good ones and bad ones and customer do not have means to distinguish between the two. How the customer will values these products with warranty and without warranty.

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A: Since there is no way to distinguish between the reliable and unreliable product the maximum the customer is willing to pay is the ...

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