Suppose buyers in the used car market are willing to pay $8,000 for a plum (high-quality) used car and $3,000 for a lemon (low-quality) used car. If buyers believe that 20% of the used cars on the market are lemons (low quality), what would they be willing to pay for a used car?

Question

Quizplus · Accepted Answer

Buyers would calculate the expected value: 80% chance of a plum ($8,000) and 20% chance of a lemon ($3,000). The expected value is 0.8 * $8,000 + 0.2 * $3,000 = $7,000.

Suppose Buyers in the Used Car Market Are Willing to Pay