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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