Home » Suppose 100 cars will be oered on the used-car market.Let 30 ofthem be good cars, each worth \$8, 000 to a buyer, and let 70 be lemons,each worth only…

# Suppose 100 cars will be oered on the used-car market.Let 30 ofthem be good cars, each worth \$8, 000 to a buyer, and let 70 be lemons,each worth only…

Q1:Suppose 100 cars will be oﬀered on the used-car market.Let 30 ofthem be good cars, each worth \$8, 000 to a buyer, and let 70 be lemons,each worth only \$2, 000 to a buyer.

1.1Compute a buyer’s maximum willingness to pay for a car if he or shecannot observe the car’s quality.

1.2 Suppose that sellers value lemons at \$1000.Suppose that there areenough buyers relative to sellers that competition among buyers leadscars to be sold at buyers’ maximum willingness to pay.What wouldthe market equilibrium price be if sellers value good cars at \$6, 000?Are all the cars sold?If not, which type is sold?Is the market outcomeeﬃcient?

1.3If you buy a new car and try to sell it in the ﬁrst year, the price youget is substantially less than the original price.Use lemons model togive one explanation for this much lower price.

1.4 Suppose that sellers value lemons at \$1000.Suppose that there areenough buyers relative to sellers that competition among buyers leadscars to be sold at buyers’ maximum willingness to pay.What wouldthe market equilibrium be if sellers value good cars at \$3, 500?Is themarket outcome eﬃcient?

Q2:The California wine market has 200 wineries, in which each winerychooses to sell one bottle of wine.Among the 200 wineries, 80 winerieshave high-quality grapes, and 120 wineries have low-quality grapes.Eachwinery can choose to turn the grapes into wine.The opportunity cost ofmaking/selling a high-quality wine is 40, and the opportunity cost of mak-ing/selling a low-quality wine is 20.A large number of risk-neutral con-sumers with identical tastes are willing to buy an unlimited number of bot-tles at their expected valuations.Each consumer values a high-quality wineat 50 and a low-quality wine at 25.By looking at the bottles, consumerscannot distinguish between high-quality and low-quality wines.

2.1If all the wineries choose to sell wine, what is a consumer’s expectedvalue of wine?If only low-quality wineries choose to sell wine, what’sa consumer’s expected value of wine?

2.2 What is the market equilibrium price?In the market equilibrium,which wineries choose to sell wine?

2.3Suppose all the high-quality grapes are grown in the Napa region ofCA and all the low-quality grapes are grown outside the Napa regionof CA. The CA legislature requires that wine bottles label where thegrapes are grown.What are the equilibrium price and quantity ofhigh-quality wine?What are the equilibrium price and quantity oflow-quality wine?

2.4 Does the market equilibrium in [2.2] exhibit a lemons problem?In-clude an analysis of whether clearly labeling the origin of the grapessolves the lemons problem.

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