Question

A common complaint is that a new car will depreciate by 25% as soon as the new owner drives it off the lot. This information comes from resale price data from cars sold just months after the initial purchase. How does adverse selection imply that most cars depreciate much less?

Answer 1

Adverse selection is a problem contagious to used car markets. It is actually incorrect to believe that most of the new cars will depreciate by 25% as soon as the owners buy it and uses it for few days. Actually in used markets there are defective cars as well as used but quality cars both sold. Because the buyers cannot predict the nature of the car they place a relatively lower value on each car type. More over, cars that are sold quite early in the used car market after their purchase are usually considered a lemon by a potential buyer. This reduces its price far more than what its value actually is. Hence adverse selection and asymmetric information are responsible for new car toe get depreciated by 25%