Other
Microeconomics FHS Problem Set 7 Sketch Solutions
- Module
- Microeconomics
- Institution
- University Of Oxford
Sketch solutions for select questions in the Microeconomics FHS Problem Set 7: Adverse Selection, Signalling & Screening
[Show more]
Content preview
UNIVERSITY OF OXFORD Last updated: September 16, 2013Department of Economics
Undergraduate - Microeconomics
Tutorial/Class 7: Adverse Selection, Signalling & Screening
Sketch solutions
FOR USE BY TUTORS ONLY
DO NOT CIRCULATE, ESPECIALLY TO STUDENTS
, Problems and Multipart Questions
1. Lemons & Peaches
Four qualities of a certain brand of car are produced in equal numbers. There are
two groups of potential consumers, none of whom wants to own more than a single
car. Three times as many are type X as are type Y . The two types place di↵erent
values on each grade of car, summarised in the table below. The price of a new car
is £16,000, and in the eyes of each consumer no depreciation occurs in the first six
months after the car has left the factory.
Quality Type X value Type Y value
(£,000) (£,000)
A 21 18
B 18 17
C 15 16
D 11 12
(a) Who buys new cars, assuming that they discover the grade only after purchase?
Assume there are 12n type X consumers and 4n type Y .
Expected value of a car to type X is 65/4 = 16 14 > 16.
Expected value of a car to type Y is 63/4 = 15 34 < 16.
So all type X’s buy new cars, and no type Y ’s do.
Therefore there are 12n cars bought, 3n of each quality.
(b) Analyse the market for six month resales, continuing to assume that consumers
are able to judge the quality of a specific car only after purchase, but that they do
know the average quality of used cars traded – i.e. if potential buyers o↵er a price
of £20,000, they know that any type Y owner would sell, but that the type X
owners would sell only if their car was grade B, C, or D. (Each potential trader
decides whether or not to trade a single used car at the prevailing price and no
later resales are possible.)
Draw supply and demand curves.
If p 21, owners with cars of all qualities will sell, supply is 12n, expected
value to type Y is 15 34 , demand is 0.
If 18 p < 21, owners with cars of qualities B, C, D will sell, supply is 9n,
expected value to type Y is 14 23 , demand is 0.
If 15 p < 18, owners with cars of qualities C, D will sell, supply is 6n,
expected value to type Y is 13, demand is 0.
If 11 p < 15, owners with cars of quality D will sell, supply is 3n, (expected)
value to type Y is 12, demand is ...?
...0 if p > 12, and 4n if p is between 11 and 12.
Excess demand forces the price up to 12.
So, only the 3n quality D cars are traded, and the sellers are each better off
by £1,000.
1
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller ib45pointer. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £2.87. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
71184 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now