Suppose there are 100 sellers, each offering one used car, and 200 buyers, each wanting one used car. A used car could be of high or low quality. There are 50 high-quality cars and 50 low-quality cars. A high-quality used car is worth $10,000 to the buyer whereas a low-quality used car is worth $2,0000 to the buyer. A seller knows the car’s quality.

(a) Suppose a buyer can observe the car’s quality. What is the buyer’s maximum willingness to pay for a high-quality car? What is the buyer’s maximum willingness to pay for a low-quality car?

(b) Now suppose a buyer cannot observe the car’s quality. What is the buyer’s maximum willingness to pay for a used car if the buyer believes that all sellers (high or low quality) are selling their used cars in the market? What is the buyer’s maximum willingness to pay for a used car if the buyer believes that only the low-quality sellers are selling their used cars in the market?

(c) Suppose a seller values a high-quality used car at $8000 and a low-quality car at $1000. What is the equilibrium price in the market if the buyers cannot observe the car’s quality? How does your answer change if a seller values a high-quality used car at $5000?

Answer rating: 100% (QA)

a If a buyer can observe the cars quality their maximum willingness to pay for a highquality car wou... View the full answer