Critical Mass Problems: Difference between revisions
| Line 21: | Line 21: | ||
Bid=''q''*''p''<sub>''L''</sub>+(1-''q'')*''p''<sub>''NL''</sub> | Bid=''q''*''p''<sub>''L''</sub>+(1-''q'')*''p''<sub>''NL''</sub> | ||
The important part to note is that the bid price will be lower than ''p''<sub>''NL''</sub> | The important part to note is that the bid price will be lower than ''p''<sub>''NL''</sub> but higher than ''p''<sub>''L''</sub>. Owners of non-lemons will have less incentive to sell their cars while owners of lemons will have more. | ||
==Tipping== | ==Tipping== | ||
Revision as of 15:49, 28 April 2009
Lemons
It is well known that as soon as a new car is bought and driven off the lot, its value drops significantly. Walrasian economics cannot explain this phenomena.
The Model:
Cars can be divided into two categories and two subcategories:
- First, a car is new or used
- Second, a car is good or bad (a "lemon" or not)
The purchaser of a new car soon finds out whether or not his car is a lemon but, importantly, he is the only one who knows this.
Someone in the market for a used car knows that the market is comprised of both lemons and non-lemons. Knowing this, the used car purchaser seeks to bid no more than a weighted average of the price they'd pay for a lemon and the price they'd pay for a non-lemon using their best estimate of the populations for each.
Let: qL=the estimated population of lemons pL=price willing to pay for a lemon pNL'=price willing to pay for non-lemon
Then,
Bid=q*pL+(1-q)*pNL
The important part to note is that the bid price will be lower than pNL but higher than pL. Owners of non-lemons will have less incentive to sell their cars while owners of lemons will have more.
