1)Why can adverse selection drive good used cars from the market?

2)

The market demand curve for a product is given below:

QD=250−0.5PQD=250−0.5P

a. Assume that the market is supplied by a monopolist with a constant unit cost equal to $100. Calculate the equilibrium price and quantity.

b. Now assume that the market is supplied by perfectly competitive firms and that the market supply curve is perfectly elastic at a price equal to $100. Calculate the equilibrium price and quantity.

1)Adverse selection is an event/occurrence in a trade whereby one of the parties involved something that other parties do not, which could cause them to reconsider the deal or renegotiate. Morally, all parties should reveal all their knowledge regarding the trade. Laws compel businesses to issue buyer-beware warnings regarding potential risks.

The market for used cars is extensively afflicted by adverse selection. Sellers always omit details about their vehicles that could devalue the asking price. Some folks just do not care about the interests or success of their customers. Trust in used vehicles wanes continuously as adverse selection reigns in the markets.

Trade cannot exist when trust is broken. Duped buyers of used cars spread the word faster than happy clients. Therefore, adverse selection continues shrinking the aggregate demand of second-hand cars, and the market may hit a recession from which it cannot emerge.

2)

a. Assume that the market is supplied by a monopolist with a constant unit cost equal to $100. Calculate the equilibrium price and quantity.

We write the inverse demand function as given:

• QD=250−0.5P0.5P=250−QPD=500−2QQD=250−0.5P0.5P=250−QPD=500−2Q

We derive the marginal curve:

• MR=dTRdQTR(Q)=P×Q=(500−2Q)QMR=500−4QMR=dTRdQTR(Q)=P×Q=(500−2Q)QMR=500−4Q

Monopolist will produce at the quantity level where MR=MCMR=MC.

Since a constant unit cost is equal to $100 or MC =100, then 500−4Q=100500−4Q=100

Solving this we get QM=100QM=100 and PM=500−2(100)=$300PM=500−2(100)=$300

So the equilibrium price and quantity where market is supplied by a monopolist is P=300 and Q=100.

b. Now assume that the market is supplied by perfectly competitive firms and that the market supply curve is perfectly elastic at a price equal to $100. Calculate the equilibrium price and quantity

The equilibrium market price is given as 100. Then the equilibrium quantity is given by:

• P=100=500−2Q2Q=400QC=200P=100=500−2Q2Q=400QC=200.

So the equilibrium price and quantity where market is supplied by perfectly competitive firms is P=100 and Q=200