Adverse selection Consider a used car market Two types of cars;"lemons"and “ peaches” Each lemon seller will accept $1, 000; a buyer will pay at most $1, 200 Each peach seller will accept $2,000 a buyer will pay at most $ 2, 400
Adverse Selection Consider a used car market. Two types of cars; “lemons” and “peaches”. Each lemon seller will accept $1,000; a buyer will pay at most $1,200. Each peach seller will accept $2,000; a buyer will pay at most $2,400
Adverse selection If every buyer can tell a peach from a lemon then lemons sell for between $1, 000 and $1, 200, and peaches sell for between $2,000 and $2, 400. Gains-to-trade are generated when buyers are well informed
Adverse Selection If every buyer can tell a peach from a lemon, then lemons sell for between $1,000 and $1,200, and peaches sell for between $2,000 and $2,400. Gains-to-trade are generated when buyers are well informed
Adverse selection Suppose no buyer can tell a peach from a lemon before buying What is the most a buyer will pay for any car?
Adverse Selection Suppose no buyer can tell a peach from a lemon before buying. What is the most a buyer will pay for any car?
Adverse selection Let q be the fraction of peaches 1-g is the fraction of lemons Expected value to a buyer of any car is at most EV=$1200(1-q)+$2400q
Adverse Selection Let q be the fraction of peaches. 1 - q is the fraction of lemons. Expected value to a buyer of any car is at most EV = $1200(1− q) + $2400q
Adverse selection Suppose EV> $2000 Every seller can negotiate a price between $2000 and sev(no matter if the car is a lemon or a peach) All sellers gain from being in the market
Adverse Selection Suppose EV > $2000. Every seller can negotiate a price between $2000 and $EV (no matter if the car is a lemon or a peach). All sellers gain from being in the market