Two types of existing houses are for sale: ones with a cracked foundation and ones without.In all other respects,they are identical.Houses without cracked foundations are worth $200,000;those with cracked foundations are worth $200,000 minus the $20,000 to fix the crack,or $180,000.The frequency of solid foundations is 80%.Sellers know which type of house they have,but buyers cannot detect a crack.No seller must sell his house in order to move,and thus no one accepts anything less than the value of their house.
-Refer to the information above.Suppose that consumers are unsophisticated and assume that houses with cracked and solid foundations are offered for sale in their true proportion.The consumer's reservation price is thus

Question

Quizplus · Accepted Answer

The consumer's reservation price is the maximum they are willing to pay for a house. Given that buyers cannot detect a crack, they will be willing to pay the same amount for both types of houses. Therefore, the reservation price will be equal to the expected value of a house, which is the weighted average of the values of houses with and without solid foundations, where the weights are the frequencies of each type.

Reservation price = (0.8 x $200,000) + (0.2 x $180,000) = $196,000

Thus, the best choice is B, with a reservation price of $196,000.

Two Types of Existing Houses Are for Sale: Ones with a Cracked