Asymmetric information can lead to two broad classes of economic problems, adverse selection and moral hazard. Define both concepts and explain any differences. (6, 300 word limit) Consider a used car market where all buyers and sellers are risk neutral. Buyers value lemons at $15,000 and good used cars at $25,000. The reservation price of lemon owners is $12,000 and for the owners of good used cars the reservation price is $22,000. Assume that the share of used cars that are lemons is and that no buyers can distinguish lemons from good used cars. (b) How much are buyers willing to pay for used cars in this market? (Hint: this will be a function of 0) (2) For what values of 0 do all potential sellers actually sell their cars?
