An old man thinks it is time to upgrade his Maserati from 2002 to a brand new model 2017. The old car has a residual value as represented by the index 500, 1000, 1500, and 2000, where 500 represents low quality (high maintenance costs) and 2000 represents high quality (low maintenance costs). Each index value is equally likely. Many students are interested in the car, which has become affordable. Assume that the gain to trade equals 250 (measured in index units).

1. (a)Suppose that neither the old man nor the students no know much about cars. This assumption represents genuine uncertainty. What is the market price of the car?
2. (b)Suppose that the old man is greedy and knowledgeable about cars, while students are clueless about the quality of the car. The old man knows the true value, while the students only know the distribution. This assumption represents extreme information asymmetry. What is the market price of the car?
3. (c)What is the welfare loss due to adverse selection?
4. (d)Students are not stupid, and they may hire a mechanic to check out the car at a cost of 100 (index units). The mechanic is clever and can tell whether the car is low qual- ity (index value of 500 or 1000) or high quality (index value 1500 or 2000). What is the market price a low quality car, and what is the market price of a high quality car?