Consider the market in 2021 for a specific type of used car, say the Ford Falcon 2014. Suppose that in use these cars have proved to be either largely trouble free and reliable, or had many things go wrong. The usual slang name for the latter type is "lemon", so for contrast assume that the former type is called "orange". Suppose that each owner of an orange values it at $12,500; he/she is willing to accept a price equal to or greater than this. Similarly, suppose that the owner of a lemon values it at $3000. If the buyers could be confident that they were buying an orange they are willing to pay $16000 for it. If the car is known to be a lemon they are willing to pay only $6000. However, there is information asymmetry in this market - only the owners know whether a car is an orange or lemon.

Almost all cars depreciate over time, and so it is with the Falcon. Every month that passes, all sellers of Falcons, regardless of the type of car, they are willing to accept $200 less than they were the month before. Also, with every passing month, buyers are maximally willing to pay $500 less for an orange than they were the previous month and $300 less for a lemon. Assume that the example in the text takes place in month 0. Seventy percent of the Falcons are oranges, and this proportion never changes. Since buyers cannot distinguish between the two types of cars they are "pooled" with buyers willing to buy a car only if the "average" price they are willing to pay exceeds the price quoted by the seller. For example, in month zero they are willing to pay (0.7)*16000 +(0.3)*6000, so any amount less than this is acceptable.

A. What is the willingness for buyer/sellers to accept/pay for 1,2,3 months (calculations)

B. Graph the willingness to accept of the sellers of oranges over the next 12 months. On the same figure, graph the price that buyers are willing to pay for a Falcon of unknown type (given that the proportion of oranges is 0.7. (Hint: Make the vertical axis range from 8,000 to 13,000.)

C. Is there a market for oranges in month 2? Why or why not?

(d) In what month does the market for oranges collapse?

(e) If owners of lemons experienced no depreciation (that is, they were never willing to accept anything less than $3,000), would this affect the timing of the collapse of the market for oranges? Why or why not? In what month does the market for oranges collapse in this case?

(f) If buyers experienced no depreciation for a lemon (that is, they were always willing to pay up to $6,000 for a lemon), would this affect the timing of the collapse of the market for oranges? Why or why not? In what month does the market for oranges collapse in this case?