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: 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:  Suppose that both buyers and sellers observe the quality. What happens?

Quizplus · Accepted Answer

Both buyers and sellers have the same valuations for good and bad cars, which means that they are likely to agree on a price for both types of cars. Since both buyers and sellers can observe the quality, they will be able to differentiate between good and bad cars and trade accordingly. Therefore, both good and bad cars are likely to be traded.

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