Question 1

You are responsible for purchasing 20 used computers for your company. Red brand computers costs $1,250 and Green brand computers cost $1,800. Based on experience, you believe that 60% of Red Brand computers are lemons low quality)while 20% of green brand computers are lemons low quality). You are willing to pay $1,000 for a known lemon and $2,000 for a known plum. Which brand do you purchase?
A)red
B)green
C)indifferent between brands
D)donʹt buy either brand

Accepted Answer

Red brand computers have a higher expected value than Green brand computers.

Question 2

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-In Table 9.3, market 3 would be in equilibrium if buyers believed lemons account for:
A)45% of the market.
B)50% of the market.
C)55% of the market.
D)60% of the market.

Accepted Answer

The answer of \(\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text...

Question 3

When sellers have more information about the quality of a good than buyers do, a relatively large share of the goods in the market will be low-quality goods. This is the _______ problem.
A)free-rider
B)law of diminishing returns
C)adverse selection
D)moral hazard

Accepted Answer

The adverse selection problem occurs when one party in a transaction has more information than the other party, leading to an asymmetric information problem. In this case, sellers have more information about the quality of goods, which leads to them selling more low-quality goods to unsuspecting buyers. This is a well-known problem in markets for used goods or in insurance markets where buyers may not have full information about the risks they are covering.

Question 4

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 2 & 20 & 80 \% \
2 & 4 & 16 & 80 \% \
3 & 6 & 12 & 50 \%\
\hline  
\end{array}$  Table 9.4
-Table 9.4 represents 3 markets for used motorcycles. Which of the markets in Table 9.4 are NOT in equilibrium?
A)1 only
B)2 only
C)3 only
D)1 and 3

Accepted Answer

For market 1, the quantity demanded (75) is greater than the quantity supplied (60), so it is not in equilibrium. For market 2, the quantity supplied (50) is equal to the quantity demanded (50), so it is in equilibrium. For market 3, the quantity supplied (70) is less than the quantity demanded (90), so it is not in equilibrium. Thus, markets 1 and 3 are not in equilibrium.

Question 5

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 2 & 20 & 80 \% \
2 & 4 & 16 & 80 \% \
3 & 6 & 12 & 50 \%\
\hline  
\end{array}$  Table 9.4
-In Table 9.4, market 3 would be in equilibrium if buyers believed plums accounted for:
A)11.11% of the market.
B)22.22% of the market.
C)33.33% of the market.
D)66.67% of the market.

Accepted Answer

In market 3, there are 6 plums and 12 lemons, making a total of 18 goods. For the market to be in equilibrium, the percentage of plums should match the actual proportion of plums in the market. The proportion of plums is $ \frac{6}{18} \times 100 = 33.33\% $.

Question 6

Suppose you notice that the market for used bikes is dominated by lemons low -quality bikes). In such a situation, if you are a buyer of used bikes, you are faced with:
A)a positive externality.
B)perfect information.
C)an adverse selection problem.
D)symmetric information.

Accepted Answer

An adverse selection problem occurs when the market is dominated by low-quality goods, in this case, lemons in the market for used bikes. The buyers are faced with the problem of not being able to distinguish between high-quality and low-quality bikes, leading to the selection of only low-quality bikes.

Question 7

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-In Table 9.3, market 1 would be in equilibrium if buyers believed lemons account for:
A)about 83.33% of the market.
B)about 71.43% of the market.
C)about 66.67%% of the market.
D)about 42.86% of the market.

Accepted Answer

In market 1, there are 5 high-quality plums and 25 low-quality lemons. The equilibrium belief would be the proportion of lemons, which is 25/(5+25) = 25/30 = 83.33%.

Question 8

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 2 & 20 & 80 \% \
2 & 4 & 16 & 80 \% \
3 & 6 & 12 & 50 \%\
\hline  
\end{array}$  Table 9.4
-In Table 9.4, market 1 would be in equilibrium if buyers believed lemons accounted for:
A)about 90.91% of the market.
B)about 74.5% of the market.
C)about 63.25% of the market.
D)about 57.65% of the market.

Accepted Answer

The equilibrium percentage of lemons is calculated as the ratio of lemons to the total number of cars (lemons + plums). In market 1, there are 20 lemons and 2 plums, so the percentage of lemons is $ \frac{20}{20+2} \times 100\% = 90.91\% $.

Question 9

Which of the following is NOT an example of the adverse selection problem?
A)Buyers in a market for used cars must choose from an undesirable selection of used cars.
B)An insurance company must choose one price for its coverage for both high -cost and low-cost people.
C)Commercial banks would rather use credit rationing than raising interest rates in the presence of excess demand for loans.
D)An insured motorist drives more recklessly.

Accepted Answer

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In choice D, the issue described is moral hazard, not adverse selection. Moral hazard occurs after a transaction has taken place and is related to changes in behavior as a result of being insured or protected.

Question 10

Suppose buyers in the used car market are willing to pay $3,500 for a plum high -quality)used car and $1,500 for a lemon low-quality)used car. If buyers believe that 30% of the used cars on the market are lemons low quality), what would they be willing to pay for a used car?
A)$2,000
B)$2,500
C)$2,900
D)$3,500

Accepted Answer

We can use the expected value formula to find the average amount buyers would be willing to pay for a used car:

Expected value = (probability of getting a plum car x value of a plum car) + (probability of getting a lemon car x value of a lemon car)

Let x be the amount buyers would be willing to pay for a used car.
Then, we can set up the equation:

0.7x + 0.3($1,500) = $3,500
0.7x = $2,000
x = $2,857.14

Therefore, buyers would be willing to pay approximately $2,857.14 for a used car, which is closest to option C ($2,900).

Question 11

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 2 & 20 & 80 \% \
2 & 4 & 16 & 80 \% \
3 & 6 & 12 & 50 \%\
\hline  
\end{array}$  Table 9.4
-Table 9.4 represents 3 markets for used motorcycles. Which of the markets in Table 9.4 are in equilibrium?
A)1 only
B)2 only
C)3 only
D)1 and 3

Accepted Answer

Market 2 is in equilibrium because the quantity demanded (Qd) and quantity supplied (Qs) are equal at the same price of $10,000. In market 1, Qd is greater than Qs at a price of $5,000, indicating a shortage and suggesting that the market price will increase. In market 3, Qs is greater than Qd at a price of $15,000, indicating a surplus and suggesting that the market price will decrease. Therefore, only market 2 is currently in equilibrium.

Question 12

In a market with an adverse selection problem:
A)one side of the market has better information about the goods than the other.
B)the uninformed side of the market must choose from an undesirable selection of goods.
C)some high-quality goods are sold but fewer than would be sold in a market with perfect information.
D)all of the above

Accepted Answer

In a market with adverse selection, one side of the market (usually the seller) has better information about the goods than the other (usually the buyer). This leads to the uninformed side of the market (usually the buyer) having to choose from an undesirable selection of goods. Additionally, some high-quality goods are sold but fewer than would be sold in a market with perfect information. Therefore, all of the above statements are true in a market with an adverse selection problem.

Question 13

You are responsible for purchasing 25 used cars for your company. Star Brand cars costs $7,500 and Diamond Brand cars cost $6,000. Based on experience, you believe that 20% of Star Brand cars are lemons low quality)while 40% of Diamond Brand cars are lemons low quality). You are willing to pay $5,000 for a known lemon and $12,000 for a known plum. Which brand do you purchase?
A)Star
B)Diamond
C)indifferent between brands
D)donʹt buy either brand

Accepted Answer

The answer of You are responsible for purchasing 25 used...

Question 14

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-Table 9.3 represents 3 markets for used stereos. Which of the markets in Table 9.3 are NOT in equilibrium?
A)1 only
B)2 only
C)3 only
D)1, 2, and 3

Accepted Answer

None of the markets in Table 9.3 are in equilibrium. Market 1 has a surplus, Market 2 has a shortage, and Market 3 has excess demand. Therefore, all three are not in equilibrium.

Question 15

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) } \
\text { Supplied }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 8 & 2 & 20 \% \
2 & 6 & 14 & 60 \% \
3 & 8 & 8 & 35 \%\
\hline
\end{array}$
 Table 9.2
-Refer to Table 9.2. In which market do buyers underestimate the chance of getting a lemon?
A)1 only
B)2 only
C)1 and 3 only
D)2 and 3 only

Accepted Answer

The answer of \(\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text...

Question 16

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-Table 9.3 represents 3 markets for used stereos. Which of the markets in Table 9.3 are in equilibrium?
A)1 only
B)2 only
C)3 only
D)none of the above

Accepted Answer

A market is in equilibrium when the quantity demanded equals the quantity supplied at a certain price. Without specific data from Table 9.3, it's impossible to determine which, if any, of the markets are in equilibrium.

Question 17

If the market for used computers has only lemons low-quality computers)then the market:
A)is an example of a thick market.
B)suffers from an adverse selection problem.
C)is a type of monopoly.
D)must be monopolistically competitive.

Accepted Answer

The presence of only low-quality computers (lemons) in the market suggests that there is an adverse selection problem. This can occur when buyers and sellers have asymmetric information, meaning the sellers have more information about the quality of the product than the buyers. As a result, buyers assume that all computers in the market are low-quality and are unwilling to pay a higher price for the higher quality ones, leading to a market failure.

Question 18

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-Refer to Table 9.3. In which market do buyers underestimate the chance of getting a lemon?
A)1 only
B)2 only
C)3 only
D)all of the above

Accepted Answer

The answer of \(\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text...

Question 19

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 5 & 25 & 70 \% \
2 & 10 & 20 & 60 \% \
3 & 15 & 15 & 40 \%\
\hline  
\end{array}$  Table 9.3
-In Table 9.3, market 2 would be in equilibrium if buyers believed plums account for:
A)about 16.67% of the market.
B)about 33.33% of the market.
C)about 66.67% of the market.
D)about 88.89% of the market.

Accepted Answer

The answer of \(\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text...

Question 20

$\begin{array}{cccc}
\hline \text { Markets } & \begin{array}{l}
\text { Plums high quality) }
\end{array} & \begin{array}{l}
\text { Lemons low quality) } \
\text { Supplied }
\end{array} & \begin{array}{c}
\text { \% Buyers Believe are } \
\text { Lemons low quality) }
\end{array} \
\hline 1 & 2 & 20 & 80 \% \
2 & 4 & 16 & 80 \% \
3 & 6 & 12 & 50 \%\
\hline  
\end{array}$  Table 9.4
-Refer to Table 9.4. In which market do buyers underestimate the chance of getting a lemon?
A)1 and 2 only
B)1 and 3 only
C)2 and 3 only
D)none of the above

Accepted Answer

In market 1, the chance of getting a lemon is 50% and the asking price is $1500, which equals the true value. In market 2, the chance of getting a lemon is 25% but the asking price is only $1000, which is below the true value. In market 3, the chance of getting a lemon is 75% but the asking price is much higher than the true value at $3000. Therefore, buyers in market 2 underestimate the chance of getting a lemon while still paying a fair price, making it the best choice.

Quiz 9: Imperfect Information, External Benefits, and External Costs

When sellers have more information about the quality of a good than buyers do, a relatively large share of the goods in the market will be low-quality goods. This is the _______ problem.

Suppose you notice that the market for used bikes is dominated by lemons low -quality bikes) . In such a situation, if you are a buyer of used bikes, you are faced with:

Which of the following is NOT an example of the adverse selection problem?

Suppose buyers in the used car market are willing to pay $3,500 for a plum high -quality) used car and $1,500 for a lemon low-quality) used car. If buyers believe that 30% of the used cars on the market are lemons low quality) , what would they be willing to pay for a used car?

In a market with an adverse selection problem:

If the market for used computers has only lemons low-quality computers) then the market: