Suppose there are only two kinds of cars in the market for used cars: lemons and good cars.A lemon is worth $1,000 both to its current owner and to anyone who buys it.A good car is worth $8,000 to its current and potential owners.Buyers can't tell whether a car is a lemon until after they have bought the car,and there is no warranty.What is the equilibrium price of a used car?
A) $8,000
B) $1,000
C) $4,500
D) $9,000
E) The equilibrium price depends on how many lemons and how many good cars are traded.

Question

Quizplus · Accepted Answer

Since buyers can't tell whether a car is a lemon or good car, they will be willing to pay only the expected value of the car. The expected value of a lemon is $1,000, and the expected value of a good car is $8,000. Therefore, the maximum price that buyers will be willing to pay for a used car is the expected value of a lemon or $1,000. Sellers of good cars will not be willing to sell at this price since their car is worth $8,000 to them. Therefore, the only cars that will be sold are lemons at a price of $1,000. This is the only equilibrium price in this market.

Suppose There Are Only Two Kinds of Cars in the Market