Consider a hypothetical used car market in which fifty percent of the cars for sale are low-quality cars and fifty percent of the cars for sale are high-quality cars. Buyers know that half of the cars are high quality and half are low quality, but they do not know which individual cars are high quality and low quality. Sellers know whether their cars are high quality or low quality. Buyers would be willing to pay at most $2,000 for a low-quality car and at most $8,000 for a high-quality car. Sellers of low-quality cars have a willingness to sell of $1,500. Sellers of high-quality cars have a willingness to sell of $7,000.Which of the following statements is true?It is efficient for the plums to be sold but not the lemons.Buyers will never buy lemons.The price of a used car will be no more than $2,000.The price of a used car will be no more than $7,000.
A)I only
B)I, II, and IV
C)II and IV only
D)III only

Question

Quizplus · Accepted Answer

The scenario described is a classic example of the "market for lemons," a term coined by economist George Akerlof. In this market, because buyers cannot distinguish between high-quality (plums) and low-quality (lemons) cars, they are only willing to pay a price that reflects the average quality of cars in the market. Since buyers are willing to pay at most $2,000 for a low-quality car and at most $8,000 for a high-quality car, but cannot differentiate between the two, the price they are willing to pay for any car will reflect the average value of the cars, which would be no more than the willingness to pay for the lower quality given the risk. However, since sellers of high-quality cars will not sell for less than $7,000, and the market cannot support a price that high due to the information asymmetry, the market price will adjust to a level where only low-quality cars are sold, if at all. This makes statement III true, as the price will indeed be no more than $2,000, the maximum buyers are willing to pay for a car when they cannot distinguish its quality.

Consider a Hypothetical Used Car Market in Which Fifty Percent