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 the owners of houses with a solid foundation will find that:
A)potential buyers are offering more than $200,000.
B)potential buyers are offering $200,000.
C)potential buyers are offering $180,000.
D)it is not worthwhile to sell their houses.

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). Thus, the owners of houses worth $200,000 will not find it worthwhile to sell their houses.

Suppose That There Are Two Types of Houses for Sale