Think of the market in 2014 for a specific kind of used car, say a 2011 Citrus. Suppose that in use these cars have proved to be either largely trouble free and reliable ("orange") or have had many things go wrong ("lemon"). Suppose that each owner of an orange Citrus values it at $12,500; he is willing to part with it for a price higher than this but not for a lower price. Similarly, each owner of a lemon Citrus values it at $3,000. We suppose that oranges are a fraction f of used Citruses and lemons the remaining fraction (1 - f). Suppose that potential buyers are willing to pay $18,000 for an orange Citrus and $8,000 for a lemon Citrus.
(a) What price would buyers be willing to pay for a 2011 Citrus of unknown type if the fraction of oranges in the population, f, were 0.6?
(b) Will there be a market for oranges if f = 0.6? Explain.
(c) What price would buyers be willing to pay if f were 0.2?
(d) Will there be a market for oranges if f = 0.2? Explain. (e) What is the minimum value of f such that the market for oranges does not collapse?