Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

342 THE ECONOMICS OF INFORMATION [CHAP. 15
marginal benefit from each additional search. (c) How many searches should a consumer undertake if
the marginal cost of each additional search is $1.00?
(a) The lowest expected price with one search is $96 þ $8
1 þ 1 ¼ $100:00.
With two searches, the lowest expected price is $96 þ $8 3 ¼ $98:67.
With three searches, the lowest expected price is $96 þ $8
4 ¼ $98:00,
With four searches, the lowest expected price is $96 þ $8 5 ¼ $97:60.
With five searches, the lowest expected price is $96 þ $8 6 ¼ $97:33.
(b) For the second search, MB ¼ $100 2 $98.67 ¼ $1.37.
For the third search, MB ¼ $98.67 2 $98.00 ¼ $0.67.
For the fourth search, MB ¼ $98.00 2 $97.60 ¼ $0.40.
For the fifth search, MB ¼ $76.00 2 $73.33 ¼ $0.27.
(c)
Note that the marginal benefit of each additional search is now much smaller than those found in the previous
problem where the range of prices was much greater.
If MC ¼ $1, then the consumer should undertake only two searches, for which MB ¼ $1.37. The consumer
should not undertake the third search because MB ¼ $0.67 for the second search and thus exceeds the MC of
the search.
ASYMMETRIC INFORMATION: THE MARKET FOR LEMONS AND
ADVERSE SELECTION
15.8 Adverse selection is the direct result of asymmetric information. (a) True or false? Explain. (b) How can
the problem of adverse selection be overcome?
(a)
(b)
True. Adverse selection refers to the driving of high-quality products out of the market by the
availability of low-quality products. This results because buyers are unable to determine the quality of
the product and thus offers a price appropriate only for average-quality products. Since sellers do know
the quality of their products (i.e., information is asymmetric), sellers of high-quality products refuse to
sell their products at the average price, and so only low-quality products will be offered for sale
(adverse selection).
The problem of adverse selection can be overcome by buyers getting more information and/or sellers providing
more information about the quality of the product or service. With more information on the quality of the
product, buyers would be willing to pay an appropriately higher price for higher-quality goods and services,
and thus avoid their withdrawal from the market. This is the purpose of brand names, national retail chains,
and professional licensing.
15.9 Suppose that there are only two types of used cars in the market: high-quality and low-quality,
and all the high-quality cars are identical and all the low-quality cars are identical. With perfect
information, the quantity demanded of high-quality used cars is zero at $16,000 and 100,000 at
$12,000, while the quantity demanded of low-quality cars is zero at $8,000 and 100,000 at
$4,000. Suppose also that the supply curve for high-quality cars is horizontal at $12,000, while
the supply curve of low-quality used cars is horizontal at $4,000 in the relevant range. (a) Drawa
figure showing that with asymmetric information, no high-quality cars will be sold and 100,000
low-quality cars will be sold at the price of $4,000 each. (b) Explain the precise sequence of
events that leads to this result.