Assume that there are 2000 owners of lemons (bad used cars). They want to sell their lemons as long as a buyer offers $12, 000 or more. There is a very large number potential buyers who are willing to pay $16,000 for a lemon or $32,000 for a good used car. There are 6000 owners of good used cars. They want to sell their good used cars as long as a buyer offers $20; 000 or more. Assume that sellers know the quality of their cars. There are 8,000 used cars in the market.

(i) If buyers know the quality of a car as soon as they see it, what are the equilibrium price of a lemon and that of a good used car?

(ii) Now suppose that buyers cannot tell the quality of a car. Find the expected value of a used car to a buyer.

(iii) Use your answer to part (ii) to find the market equilibrium if buyers cannot tell the quality of a car and they are risk-neutral.

(iv) Now, let us change an assumption by supposing that owners of good used cars are willing to sell only if they get an offer exceeding (or equal to) v = $29, 000. What is the market equilibrium in this case? Is the equilibrium efficient?