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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.

https://brainmass.com/economics/uncertainty/asymmetry-of-information-market-for-lemons-181609

#### Solution Preview

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

#### 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.

\$2.19

## Risk, Uncertainty and Information

Traders are divided into 2 groups, sellers and buyers. Each seller sells one or no cars, and each buyer buys one or no cars. There are more buyers than sellers and the market is competitive. Cars can be "lemons" with quality q=1 or "peaches" with quality q=3. The proportion of lemons is ½. The von Neumann Morgenstern utility functions of the sellers and buyer are, respectively:
Us=x+q
Ub=x+1.2q
Where x is a numeraire good with price 1.
(a) Determine the equilibrium outcome, or outcomes, when both the seller and the buyer observe directly the quality of any car traded.
(b) Determine the equilibrium outcome, or outcomes, when neither the seller nor the buyer observes directly the quality of any car traded.
(c) Determine the equilibrium outcome, or outcomes, when only the seller observes directly the quality of any car traded.
(d) Determine the equilibrium outcome, or outcomes, when there are more sellers than buyers.
(e) What are the characteristics of the "market for lemons?

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