Suppose Joe has a reliable two-year old Honda Civic that's in excellent condition and that he would be willing to sell for $13,000. Lauren, who is risk-neutral, is considering whether to buy Joe's car. She's willing to pay $14,000 for a two-year Honda Civic that is reliable and only $10,000 for one that's not reliable. Lauren cannot tell whether Joe's car is reliable, but she believes that only 20 percent of two-year old Hondas for sale in the market are reliable and that the other 80 percent are not reliable. Will Lauren buy Joe's car?

Question

Quizplus · Accepted Answer

Since Lauren is risk-neutral, the most she's willing to pay for the car is its expected value, which is $10,800 = (0.20)($14,000)+ (0.80)($10,000). Since this is less than $13,000, Joe will not be willing to sell Lauren his car.

Suppose Joe Has a Reliable Two-Year Old Honda Civic That's