Question

Consider a market where potential sellers have an informational advantage over buyers.
In this market potential sellers may possess either a high-quality or a low-quality good.

Assume that each potential seller has one good that she may either sell or retain. If the
seller has a low-quality good, it is worth $15 to her, while high-quality goods are worth
$45.

One half of the potential sellers possess high-quality goods, while the other half possesses
low-quality goods. Buyers are at an informational disadvantage, knowing only that one
half of the potential sellers possess a low-quality good and the other half possess a high-
quality good. At the time of sale, buyers are unable to discern the quality of individual
goods. Assume that buyers outnumber sellers and that buyers know the value sellers
place on high and low-quality goods.

Buyers are willing to pay $60 for a high-quality good and $20 for a low-quality good.

a. Will both high and low-quality goods sell in this market? What will be the market price?
Explain.
b. Consider the case where the buyer valuations for low and high-quality goods are
unchanged, but potential seller valuations for low and high-quality goods fall to $10 and
$30, respectively. Under these conditions will both high and low-quality goods be
traded? Explain.

c. Discuss how informational asymmetries affect market outcomes

Answer 1