Suppose there are only two kind of cars in the market for used cars: lemons and good cars.A lemon is worth $1,000 both to its current owner and to anyone who buys it.A good car is worth $8,000 to its current and potential owners.Buyers can't tell whether a car is a lemon until after they have bought the car,and there is no warranty.What is the equilibrium price of a used car?
A) $8,000
B) $1,000
C) $4,500
D) $9,000
E) The equilibrium price depends on how many lemons and how many good cars are traded.

Question

Quizplus · Accepted Answer

Since buyers cannot tell whether a car is a lemon or a good car, they will be willing to pay the average value of both types, which is (1000+8000)/2 = $4,500. However, no seller of a good car will be willing to sell for less than $8,000 because that is the value to them, so the only cars that will trade are lemons at $1,000. Therefore, the equilibrium price is $1,000, which is also the value of a lemon to its current owner.

Suppose There Are Only Two Kind of Cars in the Market