Suppose that there are two types of cars,good and bad.The qualities of cars are not observable but are known to the sellers.Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows:
$$\begin{array} { | l | l | l | }
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Beller's Valuation } \
\hline \text { Good } & & \
\text { (50\% probability) } & 5,000 & 4,500 \
\hline \text { Bad } & & \
\text { (50\% probability) } & 3,000 & 2,500 \
\hline
\end{array}$$ Suppose that both buyers and sellers observe the quality.What happens?

Question

Suppose that there are two types of cars,good and bad.The qualities of cars are not observable but are known to the sellers.Risk-neutral buyers and sellers have their own valuation of these two types of cars as follows:
$$\begin{array} { | l | l | l | } 
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Beller's Valuation } \
\hline \text { Good } & & \
\text { (50\% probability) } & 5,000 & 4,500 \
\hline \text { Bad } & & \
\text { (50\% probability) } & 3,000 & 2,500 \
\hline
\end{array}$$ Suppose that both buyers and sellers observe the quality.What happens?

Quizplus · Accepted Answer

Since both buyers and sellers observe the quality of the cars, they can differentiate between good and bad cars. In this case, both good and bad cars will be traded as buyers who value good cars at $5,000 will be willing to pay sellers who value good cars at $4,500, and similarly, buyers who value bad cars at $3,000 will be willing to pay sellers who value bad cars at $2,500. This will result in a trade of both types of cars.

Suppose That There Are Two Types of Cars,good and Bad