Question

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B. Asymmetric Information & Behavioral Economics 1. What is the equilibrium price and quantity in the used car market below? Why aren't the other 2 points labeled considered equilibrium points? Supply of high-quality cars (plums) Supply of low-quality cars (lemons) Price (S) WTP with 50/60 expectations $10,000 WTP with pessimistic expectations $4,000 40 70 30 Number of used cars sold per day

Answer 1

Here the equilibrium point is point c where equilibrium price is $4000 and quantity is 40. At this point, buyers expectations are realised they assume that at this price all the cars supplied will be lemons. And in indeed, all the cars supplied at this point are lemons. Since, the expectations of buyers are met with the reality at point (c) . Therefore point-c is the equilibrium point.

On the other hand, at point a and b , buyers expectation are 50-50 , I.e. they assume that at $10,000 - there are 50 percent chances of getting a plum (I.e. a good car ) and 50 percent chances of getting a lemon (I.e. a bad car ). But in reality, at $10,000, no. Of plums is 30 and no.of lemons is 70, I.e. there is no 50-50 ratio of plums and lemons. Since the expectations buyers does not meet reality therefore point a and point b are not equilibrium points.