In the market for flying broomsticks, buyers cannot determine the difference between a good broomstick and a superior broomstick (those with extremely fast acceleration and stopping ability) although sellers do know. Buyers value a good broomstick at $10,000 and a superior broomstick at $15,000. Buyers do know, based on a government survey, that 65% of available broomsticks are of good quality and 35% are of superior quality.

Question 1 Die Zauberlehrlingen Need New Brooms (35 Points)

Note: Assume there are no consumer protection laws or outside rating agencies and you dont get to fly before you buy. Absurd restrictions, I agree, but its my test so I get to make up the rules.

A. (5 points) What is a buyers expected value of a flying broomstick?

B. (10 points) If sellers of good broomsticks have a reservation price of $5,000 and sellers of superior broomsticks have a reservation price of $9,000, what happens in this market? Explain

C. (10 points) If sellers of good broomsticks have a reservation price of $7,500 and sellers of superior broomsticks have a reservation price of $12,500, what happens in this market? Explain.

D. (10 points) Screening is an important tool when asymmetric information is present. Assume youre in the market for a superior broomstick (since your last superior broomstick decided that broomsticking for apprentices was for the birds and ran off with your sisters water bucket for the beaches of St. Johns) and the sellers reservation prices are $6,000 for a good broomstick and $14,000 for a superior broomstick. Can you screen out the good broomsticks by offering $6,000 and when the owner turns you down, you know shes selling a superior broomstick? Will that work? Explain.