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:
$$\begin{array} { | l | l | l | }
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Beller's Valuation } \
\hline \text { Good } & & \
\text { (50\% probability) } & 5,000 & 4,500 \
\hline \text { Bad } & & \
\text { (50\% probability) } & 3,000 & 2,500 \
\hline
\end{array}$$ When a buyer does not observe the quality,what is the highest price she will offer for a used car if she ignores adverse selection?

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:
$$\begin{array} { | l | l | l | } 
\hline \text { Types of Cars } & \text { Buyer's Valuation } & \text { Beller's Valuation } \
\hline \text { Good } & & \
\text { (50\% probability) } & 5,000 & 4,500 \
\hline \text { Bad } & & \
\text { (50\% probability) } & 3,000 & 2,500 \
\hline
\end{array}$$ When a buyer does not observe the quality,what is the highest price she will offer for a used car if she ignores adverse selection?

Quizplus · Accepted Answer

If the buyer ignores adverse selection, she will calculate the expected value of a car, which is the average of the valuations of good and bad cars: $(5000 + 3000) / 2 = 4000$. This is the highest price she will offer.

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