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There are three types of cars, the good G, the bad B, and the ugly U.A G car is worth $40, a B car is worth $20, and a U car is worth $15.The seller knows the precise quality of his car, but the buyer cannot distinguish the difference in the quality of a car offered for sale.There is an equal probability of a car being G, B, or U.
-In equilibrium, which car is offered for sale and at what price?
A)B and U, at a price = $25
B)U only, at a price = $17.5
C)U only, at a price = $15
D)U only, at a price = $0
E)No car will be offered for sale since the rational expectations price is $0

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There are three types of cars, the good G, the bad B, and the ugly U.A G car is worth $40, a B car is worth $20, and a U car is worth $15.The seller knows the precise quality of his car, but the buyer cannot distinguish the difference in the quality of a car offered for sale.There is an equal probability of a car being G, B, or U.
-In equilibrium, which car is offered for sale and at what price?
A)B and U, at a price = $25
B)U only, at a price = $17.5
C)U only, at a price = $15
D)U only, at a price = $0
E)No car will be offered for sale since the rational expectations price is $0

Quizplus · Accepted Answer

In equilibrium, the seller will offer only U cars for sale because the expected value of selling a U car is higher than that of selling a B car or a G car. The expected value of selling a U car is ($15 x 1/3) = $5, whereas for B and G cars it is ($20 x 1/3) + ($40 x 1/3) = $20/3. Therefore, offering only U cars for sale is the rational decision for the seller. The price at which the U car will be sold is the expected value of selling a U car, which is $15 x 1/3 = $5. However, since the buyer cannot distinguish between the quality of the cars, they will only offer an average price of ($40 + $20 + $15)/3 = $25/3. Therefore, the seller will have to accept a lower price of around $17.5 to sell their U car.

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