Question
You are considering buying a used car from a seller. Only the seller knows the quality of the car. You believe that the quality of
You are considering buying a used car from a seller. Only the seller knows the quality of the car. You believe that the quality of the car, measured by some quality index which ranges between 0 and 1, is distributed uniformly between 0 and 1; here "0" and "1" represent the worst and the best qualities, respectively. You value a car of quality x at $10000x, while you believe that the seller's valuation of the same car is $9500x. If your beliefs on the seller's valuation are sufficiently accurate, there are potential gains from trade between you and the seller. In other words, whatever the true quality x is, it is socially desirable for you and the seller to trade. Given x, any transaction at a price between 9500x (the seller's valuation) and 10000x (your valuation) would improve your welfare as well as the seller's. Suppose that both you and the seller are risk neutral expected utility maximizers. How much should you pay for the used car?
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