Consider the market for used cars shown in the figure below. The top panel (a) shows the market for low-quality cars (lemons); the bottom panel (b) shows the market for high-quality cars (plums). If all buyers and sellers had full information about the quality of automobiles being offered for sale, lemons would sell for $8,000 and plums would sell for $16,000.

a. Suppose that buyers recognize that the chance of getting a lemon is 50%, but are unable to tell whether a car is a lemon or a plum. What is the expected value of a used car to a buyer?
b. If the market works to the extent that prices reflect the expected value of a used car, how many high-quality automobiles will be offered for sale at the price determined in (a)? How many low-quality automobiles will be offered for sale? Of the automobiles offered for sale, what is the proportion of low-quality automobiles?
c. Compared to a market with perfect information, what kind of deadweight loss does the information loss generate in the market for high-quality used cars? Is there a deadweight loss in the market for lemons, too?

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(a) Lemons (b) Plums Price (S/car) Price (S/car) $16,000 $8,000 4,000 2,000 0 Quantity of used cars 0 Quantity of used cars 600 600