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Chapter 8: Q.23 (page 236)

Refer to Problem 22. Now you believe the dealer knows more about the car than you do. How much are you willing to pay? Why? How can this asymmetric information problem be resolved in a competitive market?

Short Answer

Expert verified

The buyer desired to pay less than $24,000. The seller knows more about the value of used cars than the buyer, but the buyer does not want to pay more than $24,000due to a lack of knowledge.

Step by step solution

01

Content Introduction

Asymmetric information refers to incomplete information between two parties; therefore, any difference in information provided to people other than the true information leads to inconsistency and market failure.

02

Content Explanation

The buyer desired to pay less than . The seller knows more about the value of used cars than the buyer, but the buyer does not want to pay more than due to a lack of knowledge.

As a result, because both parties have different knowledge, the deal will be set between $20,000and $24,000. It causes asymmetric information problems, which cause adverse selection and moral hazards.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database and find data on net worth of households (TNWBSHNO) and the net percentage of domestic banks tightening standards for auto loans (STDSAUTO). Adjust the units setting for the net worth indicator to 鈥淧ercent Change from Year Ago,鈥� and download the data into a spreadsheet.

a. Calculate the average, over the most recent four quarters and the four quarters prior to that, for the bank standards indicator and the 鈥減ercent change in net worth鈥� indicator. Do these averages behave as you would expect?

b. Use the Data Analysis tool in Excel to calculate the correlation coefficient for the two data series from 2011:Q2 to the most recent quarter of data available. What can you conclude about the relationship between the net worth of households and bank auto lending standards? Is this result consistent with efforts to reduce asymmetric information?

You are in the market for a used car. At a used car lot, you know that the Blue Book value of the car you are looking at is between \(15000 and \)19000. If you believe the dealer knows as much about the car as you do, how much are you willing to pay? Why? Assume that you care only about the expected value of the car you will buy and that the car values are symmetrically distributed.

What are the transaction costs problems facing financial organizations? Explain how financial intermediaries can help reduce these problems.

What steps can the government take to reduce asymmetric information problems and help the financial system function more smoothly and efficiently?

How can asymmetric information problems lead to a bank panic?
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