Suppose that there are two types of houses for sale: those with solid foundations and those with cracked foundations. In all other respects, the two types of houses are identical. Houses with solid foundations are worth $200,000, while those with cracked foundations are worth $200,000 minus the $20,000 to fix the crack, or $180,000. Sellers know which type of house they have, but buyers cannot detect whether the foundation has a crack. Suppose that 80 percent of the houses for sale have a solid foundation and 20 percent of the houses for sale have a cracked foundation. If buyers are risk-neutral and know the that 80 percent of the houses for sale have a solid foundation while 20 percent have a cracked foundation, then how much will buyers be willing to pay for a house?
A)$200,000
B)$196,000
C)$180,000
D)$160,000

Question

Quizplus · Accepted Answer

Buyers will be willing to pay the expected value of a house, which is $196,000 = (0.80)($200,000)+ (0.20)($180,000).

Suppose That There Are Two Types of Houses for Sale