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(ECON150)[2010](f)midterm~thu^_10226.pdf
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Econ150.
Fall.2010.
Francis.Lui.
Midterm.Exam.
.
1)
The.competitive.market.mechanism.is.said.to.possess.some.desirable.properties:.


a)
It.is.information.efficient;.


b)
It.is.self\correcting;.


c)
It.makes.all.parties.involved.better.off..



Briefly.explain.why.the.market.mechanism.might.have.these.properties..(15.points).Solution:.

a)
Firms.only.look.at.the.market.price.and.their.own.cost.functions..So.long.as.the.price.exceeds.marginal.cost,.they.will.produce.more..They.will.produce.a.quantity.at.which.the.price.is.equal.to.marginal.cost..Consumers.also.only.look.at.the.price..They.can.then.decide.how.much.they.should.buy,.given.their.own.preferences..


b)
Once.a.firm.discovers.that.it.has.produced.too.much.or.that.it.has.not.minimized.costs,.it.will.correct.the.mistakes..Otherwise,.it.may.not.even.survive..


c)
If.this.is.not.true.for.a.party,.then.it.can.refuse.to.participate..For.instance,.consumers.can.refuse.to.buy.if.they.do.not.believe.that.the.goods.worth.more.than.their.prices..Firms.will.not.produce.if.they.do.not.anticipate.that.profits.can.be.made..



.
2)
.(A).A.common.phenomenon.in.the.automobile.market.is.that.once.a.new.car.is.driven.on.the.street.for.a.day.or.so,.it.will.instantly.lose.as.much.as.a.quarter.of.its.market.value..In.what.sense.can.the.concept.of.adverse.selection.explain.this.phenomenon?.(12.points).

Solution:.
In.this.model,.as.quality.is.undistinguishable.beforehand.by.the.buyer.(due.to.the.asymmetry.of.information),.incentives.exist.for.the.seller.to.pass.off.low\quality.goods.as.higher\quality.ones..The.buyer,.however,.takes.this.incentive.into.consideration,.and.takes.the.quality.of.the.goods.to.be.uncertain..Only.the.average.quality.of.the.goods.will.be.considered,.which.in.turn.will.have.the.side.effect.that.goods.that.are.above.average.in.terms.of.quality.will.be.driven.out.of.the.market..This.mechanism.is.repeated.until.a.no\trade.equilibrium.is.reached..Sellers.have.no.credible.disclosure.technology.(sellers.with.a.great.car.have.no.way.to.disclose.this.credibly.to.buyers)..
.
(B).In.the.early.1980s,.the.automobile.manufacturer.Chrysler.was.losing.a.lot.of.money..It.then.introduced.a.strategy.that.had.successfully.rescued.the.company.from.further.losses..What.was.the.strategy?.In.what.sense.can.the.concept.of.costly.signaling.explain.the.success?.(13.points).
Solution:.
Chrysler.introduced.a.warranty.program.that.those.buying.a.new.Chrysler.would.have.a.5\year.warranty..During.this.period,.if.a.Chrysler.had.a.problem.the.customer.could.take.it.back.to.the.dealer.and.have.it.repaired.free.of.charge...
If.Chrysler.cars.were.bad,.then.many.car.owners.would.eventually.send.their.cars.back.for.repair..Chrysler.would.actually.lose.money.because.of.the.high.repair.costs..The.fact.that.Chrysler.itself.was.willing.to.launch.the.program.suggested.that.Chrysler.was.confident.that.the.high.quality.of.its.cars.does.not.require.these.repairs