1. Managerial Economics-Charles W. Upton The Market for Lemons

2. Every year n cars are available for sale, of which p turn out to be “lemons”

3. 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 B G for a good car and B L for a lemon Sellers are willing to sell cars at S G and S L

4. 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 B G for a good car and B L for a lemon Sellers are willing to sell cars at S G and S L S L < S G B L <B G B G >S G B L >S L

5. The Market for Lemons BGBG BLBL SLSL Np P Q D S N(1-p) P Q D S SGSG Gems Lemons

6. The Market for Lemons BGBG Buyers can tell the difference BLBL SLSL Np P Q D S N(1-p) P Q D S SGSG Gems Lemons Lemons sell for B L

7. The Market for Lemons BGBG Buyers can tell the difference BLBL SLSL Np P Q D S N(1-p) P Q D S SGSG Gems Lemons Gems sell for B G

8. The Market for Lemons If Buyers cannot tell the difference P = pB L + (1-p)B G

9. The Market for Lemons A numerical example VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P30%

10. The Market for Lemons A numerical example If buyers can distinguish P G = $14,000 P L = $8,000 VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P30%

11. The Market for Lemons A numerical example If buyers cannot distinguish P = pB L +(1-p)B G P = (0.3)($8,000) + (0.7)($14,000) = $12,200 VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P30%

12. The Market for Lemons Different Numbers If buyers cannot distinguish P = pB L +(1-p)B G P = (0.4)($8,000) + (0.6)($14,000) = $11,600 VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P40%

13. The Market for Lemons Different Numbers If buyers cannot distinguish P = pB L +(1-p)B G P = (0.4)($8,000) + (0.6)($14,000) = $11,600 VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P40%

14. The Market for Lemons The Tilting Point P = pB L +(1-p)B G $12,000 = p($8,000) + (1-p)($14,000) VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P

15. The Market for Lemons The Tilting Point P = pB L +(1-p)B G $12,000 = p($8,000) + (1-p)($14,000) VariableValue SGSG $12,000 SLSL $6,000 BGBG $14,000 BLBL $8,000 P

16. The Market for Lemons A More General Model P QoQo S

17. The Market for Lemons A More General Model P QoQo S Demand is a function of price and average quality

18. The Market for Lemons A More General Model P QoQo S Demand is a function of price and average quality The lower the price the greater the quantity demanded

19. The Market for Lemons A More General Model P QoQo S Demand is a function of price and average quality But quality matters as well!

20. The Market for Lemons Tweaking the Model P QoQo S

21. The Market for Lemons No Market Clearing Price P QoQo S

22. The Market for Lemons Multiple Equilibriums P QoQo S

23. The Market for Lemons End ©2004 Charles W. Upton