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The Market for Lemons P S D D( P, Q( P)) Qo Lectures in Microeconomics-Charles W. Upton The Market for Lemons • Every year n cars are available for sale, of which p turn out to be “lemons” The Market for Lemons The Market for Lemons • Every year n cars are available for sale, of which p turn out to be “lemons” • Buyers would be willing to pay BG for a good car and BL for a lemon • Sellers are willing to sell cars at SG and SL The Market for Lemons The Market for Lemons • Every year N cars are available for sale, of which p turn out to be “lemons” • Buyers would be willing to pay BG for a good car and BL for a lemon • Sellers are willing to sell cars at SG and SL SL < S G BG>SG BL<BG BL>SL The Market for Lemons The Market for Lemons P P S S Gems Lemons BL D BG SL SG D Q Np The Market for Lemons Q N(1-p) Buyers can tell the difference P S Lemons P Lemons sell S for B L Gems BL D BG SL SG D Q Np The Market for Lemons Q N(1-p) Buyers can tell the difference P GemsSsell Lemons for BG P S Gems BL D BG SL SG D Q Np The Market for Lemons Q N(1-p) If Buyers cannot tell the difference P = pBL + (1-p)BG The Market for Lemons A numerical example Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 30% The Market for Lemons A numerical example Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 30% • If buyers can distinguish PG = $14,000 PL = $8,000 The Market for Lemons A numerical example Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 30% • If buyers cannot distinguish P = pBL +(1-p)BG P = (0.3)($8,000) + (0.7)($14,000) = $12,200 The Market for Lemons Different Numbers Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 40% • If buyers cannot distinguish P = pBL +(1-p)BG P = (0.4)($8,000) + (0.6)($14,000) = $11,600 The Market for Lemons Different Numbers Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 40% • If buyers cannot distinguish P = pBL +(1-p)BG P = (0.4)($8,000) + (0.6)($14,000) = $11,600 The Market for Lemons The Tilting Point P = pBL +(1-p)BG Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 $12,000 = p($8,000) + (1-p)($14,000) The Market for Lemons The Tilting Point 1 p 3 Variable SG SL BG BL P Value $12,000 $6,000 $14,000 $8,000 P = pBL +(1-p)BG $12,000 = p($8,000) + (1-p)($14,000) The Market for Lemons A More General Model S P D D ( P, Q ( P )) The Market for Lemons Qo A More General Model P Demand is a function S of price and average quality D D ( P, Q ( P )) The Market for Lemons Qo A More General Model P The lower the price the greater the quantity demanded Demand is a function S of price and average quality D D ( P, Q ( P )) The Market for Lemons Qo A More General Model P But quality matters as well! Demand is a function S of price and average quality D D ( P, Q ( P )) The Market for Lemons Qo Tweaking the Model S P The Market for Lemons Qo No Market Clearing Price P S The Market for Lemons Qo Multiple Equilibriums P S The Market for Lemons Qo End ©2004 Charles W. Upton The Market for Lemons