Figure 9.1
-Figure 9.1 represents the market for used bikes. Suppose buyers are willing to pay $200 for a plum (high-quality) used bike and $50 for a lemon (low-quality) used bike. Initially buyers believe that 50% of used bikes in the market are lemons (low quality). Compared to the outcome with neutral expectations, how many fewer bikes are sold in equilibrium?

Question

Quizplus · Accepted Answer

If buyers have neutral expectations, the market would clear at a quantity where the price of a plum bike ($200) equals the price of a lemon bike ($50) multiplied by the proportion of lemons in the market (0.5). Thus, 200 = 50(0.5)Q, which gives Q = 8.

If buyers believe that 50% of bikes are lemons, all bikes will be priced as if they were lemons since buyers cannot distinguish between lemons and plums before purchasing. Thus, the price of all bikes will be $50, and the equilibrium quantity will be the intersection of the demand curve (which is horizontal at a price of $50) and the supply curve. This equilibrium quantity is 6.

Therefore, compared to the outcome with neutral expectations, 2 fewer bikes are sold in equilibrium (8 - 6 = 2).

Figure 9.1 -Figure 9.1 Represents the Market for Used Bikes. Suppose Buyers