1. (Mishkin 8.7) Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or for those traded over-the-counter? Explain. 2. (Mishkin 8.16) Which firms are most likely to use bank financing rather than issue bonds or stocks to finance their activities? Why? 3. (Mishkin 8.22) You are in the market for a used car and decide to visit a used car dealership. You know that the Blue Book value of the car you are looking at is between $20,000 and $24,000. If you believe the dealer knows as much about the car as you do, how much are you willing to pay? Why? Assume that you care only about the expected value of the car you will buy and that the car values are symmetrically distributed.
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The lemons problem refers to the issue of asymmetric information in the market, where the seller has more information about the quality of the product than the buyer. In the context of stocks, the lemons problem would be more severe for stocks traded Show more…
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Consider a used car market with asymmetric information. The owners of used cars know what their vehicles are worth but have no way of credibly demonstrating those values to potential buyers. Thus, potential buyers must always worry that the used car they are being offered may be a low-quality "lemon." a. Suppose that there are equal numbers of good and bad used cars in the market and that good used cars are worth $13,000 while bad used cars are worth $5,000. What is the average value of a used car? b. By how much does the average value exceed the value of a bad used car? By how much does the value of a good used car exceed the average value? c. Would a potential seller of a good used car be willing to accept the average value as payment for her vehicle? d. If a buyer negotiates with a seller to purchase the seller's used car for a price equal to the average value, is the car more likely to be good or bad? e. Will the used-car market come to feature mostly—if not exclusively—lemons? How much will used cars end up costing if all the good cars are withdrawn?
Andrew D.
Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or for those traded over-the-counter? Explain.
# 2: Suppose there is asymmetric information in the market for used cars. Sellers know the quality of the car they are selling, but buyers do not. Buyers know that there is a 30% chance of getting a "lemon", a low quality used car. A high quality used car is worth $30,000, and a low quality used car is worth $15,000. Based on the probability, the most that a buyer would be willing to pay for a used car is $_______ (round response to the nearest whole dollar)
Azat N.
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