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Suppose there are three types of used cars that consumers are willing to purchase: “Good”; “OK”; and “Bad”. Consumers are willing to pay \$10,000 for a Good car, and because they will require more work, consumers are willing to pay \$7,000 for an OK car, and \$3,000 for a Bad car. All types of car appear identical to consumers—the only differences are with regard to latent mechanical and electronic attributes that can be detected only by an expert. Although there is no way for consumers to determine the type of car they are purchasing before they purchase, all consumers know that 50% of used cars are Good, 25% are OK, and 25% are Bad. Further, consumers will be able to determine what type of car they have purchased after owning the car for 3 months.

Suppose that the attached table describes the minimum price that sellers of different types of cars are willing to accept from a buyer. Given these values, what type of cars will be sold in the market?

A) Good cars only

B) Good and OK cars only

D) OK and Bad cars only

E) There is not enough information to answer this question

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Step 1

It is given that the buyers are willing to pay \$10,000 for a good car, \$7,000 for an OK car and \$3,000 for a bad car. The buyers cannot identify the good, bad and OK cars by just looking at them. It is also given that 50% of the cars are good, 25% cars are bad and 25% cars are OK. So, the buyers will be willing to pay the amount based on the expectations of as car being a good, OK or bad.

Step 2

The amount that the buyers will be willing to pay is:

Amount that buyers are willing to pay for a car = 50% of 10,000 + 25% of 7,000 + 25% of 3,000

= \$5,000 + \$1,750 + \$750

= \$7,500

Step 3

It is also given that the minimum selling price of good cars is \$9,500, for OK cars is \$6,500 and for bad cars ...

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