spent on hospital care What about well care 5 points V Adver

spent on hospital care? What about well care? (5 points) V Adverse Selection. 7. (a) In Akerlof\'s lemons problem, with symmetric information, suppose that 5 cars are available with quality levels 0, 1, 2, 3, and 4. If the sellers have a reservation price of $2,000 per unit of quality, and the buyers value cars at $3,000 per unit of quality, what will the equilibrium price per car be? (5 points) (b) Now suppose that sellers know the quality of the car but the buyers do not, what would happen? (5 points) (c) Discuss how Akerlof\'s lemons problem applies to health insurance market. (5 points)

Solution

a. In case of symmetric information, the buyers know exactly what quality of car are they purchasing and hence equilibrium price of each car will be equal to the reservation price of the seller as the seller would not know the buyer\'s willingness to pay and would not be able to extract profit i.e for qualitu 0, price will be 0, for quality 1, price will be 2,000, for quality 2, price will be 4,000 for quality 3, price will be 6,000 , for quality 4, price will be 8,000

b. In the second case, when the buyers don\'t know the quality of the car but the sellers do, there will be an issue of adverse selection and in this case sellers can take advantage in the form of prices. The equilibrium price in this case will be the average of all reservation prices for each type of car i.e (0 + 2000 + 4000 + 6000 + 8000) / 5 = 4,000. That is, each car irrespective of the quality will be sold at 4,000

c. In the health insurance market, a similar problem of adverse selection occurs as in akerlof\'s lemon market. The insurance provider in this case doesn\'t know the health condition of the person seeking insurance and hence in this csse health seekers act as lemons and there is a chance of picking up a person with poor health condition which would not be so profitable for the insurance company as they will have to pay the bills frequently.