Question

Carlos is risk-neutral and has an ancient farmhouse with great character for sale in Slaterville Springs. His reservation price for the house is $130,000. The only possible local buyer is Whitney, whose reservation price for the house is $150,000. The only other houses on the market are modern ranch houses that sell for $125,000, which is exactly equal to each potential buyer’s reservation price for such a house. Suppose that if Carlos does not hire a realtor, Whitney will learn from her neighbor that Carlos’s house is for sale and will buy it for $140,000. However, if Carlos hires a realtor, he knows that the realtor will put him in touch with an enthusiast for old farmhouses who is willing to pay up to $300,000 for the house. Carlos also knows that if he and this person negotiate, they will agree on a price of $250,000.

If realtors charge a commission of 5 percent of the selling price and all realtors have opportunity costs of $2,000 for negotiating a sale, will Carlos hire a realtor?

Carlos  (Click to select)  will  will not  hire a realtor.

How will total economic surplus be affected?

Total economic surplus without the realtor: $

Total economic surplus with the realtor (including the realtor's surplus): $

Answer 1

Part A

Carlos will hire a realtor

Part B

Total surplus increased

Part C

$20,000

Part D

$248,000

Explanation:-

Carlos will hire the realtor because he sells the house at $250,000 and pays the realtor $12,500, for a net price of $237,500, which is above Whitney’s offer of $140,000. Without a realtor, the total economic surplus would have been only $20,000.

With the realtor, the total surplus is $248,000. Divided as follows, $107,500 for Carlos, $130,000 for buyers, 10,500 for a realtor (For realtor commission of $12,500 minus opportunity cost).