Question

Please I need today answer for This question and it is very important and I need solution for this issue with all the details , and help me with all the details.Please write your answer to me by typing, not by handwriting, so that I can read and understand your answer clearly.BR/Hassan.

After having had his Death star blown up, Mr Vader wants to console himself by buying a used space ship. Just like all other buyers of used space ships on the perfectly competitive market he is willing to pay 30000 USA for a lemon (a bad used space ship) and 60000 USA for a plum (a nice used space ship). The sellers are prepared to sell lemons for a minimum of 30000 USA and plums for 50000 USA. The buyers cannot distinguish the lemons from the plums when purchasing a spaceship while the sellers know what they are selling. The buyers’ and the sellers’ valuations of the spaceships are common knowledge.

a) Assuming that the proportion of lemon space ships is 40% (the buyers know this), what would the market equilibrium price for a used spaceship be?

b) Is the market outcome efficient? Explain!

c) If the buyers actually could distinguish lemons from plums, what would the market price be for each type of spaceship? Would this be an efficient market outcome?

d) Assume, as under a) and b) that buyers cannot distinguish between lemons and plums and the proportion of lemons is still 40%. Assume further that there is a professional spaceship expert, “Jabba the honest”, that offers to sell guarantees to plum owners stating that their space ship is, indeed, a plum and not a lemon. Let us also assume that Jabba knows whether a ship is a plum or not and that everybody believes in Jabba’s guarantee. What is the maximum price that Jabba can charge for his guarantee?

Answer 1

A)Assume there are 100 used space ships. And hence, 40% , i.e. 40 space ships are lemons while 60 space ships are plums.

Price for lemon= $30000

Price for Plum= $50000

If the quality is known to both the seller and the buyer then the price will be $30000 for a lemon and $50000 for a plum. Here, there exists a situation of symmetric information.

Since buyers cannot distinguish between a lemon or a plum, we have a situation of asymmetric information. As a result of this, the buyer will be willing to buy at the 'expected price' of the used space ship. Hence, there's a 40% possibility that the ship is a lemon and 60% probability that the ship is a plum.

The expected price will be,

Pe=[(40÷100) * 30000] +[(60÷100)* 50000]

Pe= $42000

Hence, the equilibrium price for a used spaceship will be $42000.

B) This outcome is not efficient as the equilibrium price of $42000 is too low for the seller of a plum. Hence, the seller of a plum will not sell the spaceship. However, the seller of a lemon was expecting $30000 and is getting $42000 which is way higher. Hence, all the used spaceships sold in this market will be lemons. Here, the lemons drive the plums out of the market and this becomes a 'market for lemons'.

C) If the buyers could distinguish between the lemons and plums, the market price for lemons' would be $30000 and price for plums would be $50000. This will be an efficient outcome as both the used spaceships are sold at their actual value according to their quality due to symmetric information.

D) Jabba can charge maximum upto $8000 to the owners of the plums for his guarantee as it's the difference between what the plum sellers should get and what they expect they will get without the guarantee, i.e. (50000-42000)= $8000