Consider a financial market with two assets: peaches and lemons. The fraction of lemons in the economy is λ = 0.4. Buyers value peaches at up = $20 and lemons at v = $10. Sellers value peaches at vs = $16 and lemons at vi = $8. Sellers have all the bargaining power when setting prices at which assets trade. a) Assume both buyer and sellers can perfectly observe the quality of assets in the market. At what price will lemons and peaches trade? b) Now assume that the quality of assets is unobservable, but that buyers and sellers have symmetric information. That is, neither sellers or buyers can tell whether a particular asset is a lemon or a peach. What is the (pooling) price P* at which assets trade? c) Now assume that only sellers can observe the quality of assets, so that there is asym- metric information between buyers and sellers. Explain (intuitively, without equations) why the quality of assets traded in equilibrium will now depend on the price

Consider a financial market with two assets: peaches and lemons. The fraction of lemons in the economy is λ = 0.4. Buyers value peaches at up = $20 and lemons at v = $10. Sellers value peaches at vs = $16 and lemons at vi = $8. Sellers have all the bargaining power when setting prices at which assets trade. a) Assume both buyer and sellers can perfectly observe the quality of assets in the market. At what price will lemons and peaches trade? b) Now assume that the quality of assets is unobservable, but that buyers and sellers have symmetric information. That is, neither sellers or buyers can tell whether a particular asset is a lemon or a peach. What is the (pooling) price P* at which assets trade? c) Now assume that only sellers can observe the quality of assets, so that there is asym- metric information between buyers and sellers. Explain (intuitively, without equations) why the quality of assets traded in equilibrium will now depend on the price

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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