Question

5 . Individual Problems 19-1

In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the “residual value,” computed as 60% of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, manufacturers lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).

Suppose two customers have leased cars from a manufacturer. Their lease agreements are up, and they are considering whether to keep (and purchase at 60% of the new car price) their cars or return their cars. Two years ago, Lucia leased a car valued new at $13,500. If she returns the car, the manufacturer could likely get $9,450 at auction for the car. Sharon also leased a car, valued new at $15,000, two years ago. If she returns the car, the manufacturer could likely get $7,800 at auction for the car.

Use the following table to indicate whether each buyer is more likely to purchase or return the car.

Buyer	Keep and Purchase Car	Return Car
Lucia
Sharon

The manufacturer will lose money (at auction, relative to the residual value of the car) if (Sharon, or Lucia) returns the car instead of keeping and purchasing it.

True or False: Setting a more accurate residual price of each car would help attenuate the problems of adverse selection.

True

False

Answer 1

Answer:-

Lucia's car has valued new at $13,500.

If she keep and purchase car then she has to pay ($13,500 * 0.60 ) = $8,100.

However the value of car at auction is $9,450.

So , Lucia is better off purchasing and keeping the car .

Sharon's car valued new at $15,000.

If she keeps and purchase car then she has to pay ($15,000 * 0.60 )= $9,000.

However the value of car at the auction is $7,800.

So , Sharon is better off returning the car and then trying to purchase it at auction.

The value of Sharon's car is less at auction relative to Lucia's car .

The manufacturer will lose money at auction relative to residual value of the car if Sharon's return the car instead of keeping it .

It is True that setting a more accurate residual price of each car would help attenuate the problems of adverse selection.

TRUE statement .