Selection causes this market to partial market breakdown

Assignment Help Operation Management

Reference no: EM132116661

A second-hand car dealer is doing a promotion of a certain model of used truck. Due to differences in the care with which the owners used their cars, there are four possible quality levels (q1 > q2 > q3 > q4) of the trucks on sale. Suppose that the dealer knows the car’s quality (quite obvious), but buyers only know that cars for sale can be of quality q1, q2, q3 or q4. Faced with a given car, the buyers cannot identify its precise quality. However, they believe that there is a probability 0.2 that the quality is q1, a probability 0.3 that it is q2, and a probability 0.3 that it is q3. The respective values of the cars to the buyers are $20,000 for the q1 quality, $15,000 for q2, $10,000 for q3 and $5,000 for q4.

Assume that all agents (including the buyers) are risk neutral (only care about “return”) in the sense that a buyer does not want to pay more for a car than its expected worth and the car owner (the car dealer) does not wish to sell at less than what the car is worth.

a) Define adverse selection in general and in the current context.

b) If all four types of used truck are offered for sale, what is the highest price a buyer would be willing to pay for a used truck? At this price, what type(s) of truck will be offered for sale?

c) Now suppose the $20,000 trucks are no longer offered for sale but other types are (and is known to the buyers). What is the maximum price a buyer is willing to pay for a used truck? At this price, what type(s) of truck will be offered for sale? [Hint: What are the respective probabilities of the types of cars that will be offered for sale?]

d) Explain how adverse selection causes this market to a partial market breakdown (i.e., only the worst used trucks (q4 type) are traded in the market).

Reference no: EM132116661

Questions Cloud

What happens to the demand for sara sweatshirts : What happens to the demand for Sara's sweatshirts in the long run? What happens to Sara's economic profit in the long run?

What is the probability that the product : The lifetime of the product is assumed to follow an exponential distribution. What is the probability that the product will last less than 800 hours?

What was the average cost per share of treasury stock : How many shares of Exxon mobile or outstanding December 31, 2015? What was the average cost per share of treasury stock held at the end of 2014

Clearly state null and research hypotheses : Clearly state null and research hypotheses in terms of the mean scores on distraction resistance, µ, of children with bilingual upbringing.

Selection causes this market to partial market breakdown : Define adverse selection in general and in current context. Explain how adverse selection causes this market to a partial market breakdown

Calculate sara profit-maximizing output : Sara is a dot.com entrepreneur who has established a Web site at which people can design and buy sweatshirts. Sara pays $1,000 a week for her Web server.

Comparison distribution for the sample z score : (a) Clearly state null and research hypotheses in terms of the mean scores on the memory performance on negative words, µ, of anxious individuals.

Which of the markets is example of monopolistic competition : The four-firm concentration ratio for audio equipment makers is 30, and for electric lamp makers it is 89. The HHI for audio equipment makers is 415.

Performed poorly in some of the first few quizzes : A student taking DS 412, thinking the class did not seem to be so challenging, performed poorly in some of the first few quizzes

User Account

All Pages