Page 425 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes
Fig. 30.1

Good Cars Bad Cars

E S
P G
G
E
E 1 P' B 1 S B
P' D E
G G P
B
D'
B
D'
G
D
B
O O
Q' Q Q B Q' B
G G

(A) Good Cars Quantity (B) Bad Cars Quantity
Pooling and Guarantees

The above analysis is called Pooling Equilibrium because good cars and bad cars are conjugated
in the market. Which results the owner of good cars is in loss because they can’t sell their cars. To
solve this problem, sellers guarantee the customer in situation of any problem in car. Only the bad
cars owner gives guarantee. Suppose that an average cost of repairing is 5000 for a bad car. So the
customer would pay at the time of purchasing the car 60,000 – 55,000 for each car. But if the average
cost of repairing is 10,000 then the customers will pay only 60,000 – 10,000 = 50,000. But the
bad cars are not being sold on this price. As per concern of good cars, the customers know that the
seller will take high price and the quartered is not needed. Still the seller good cars give the warranty
to their customer. A warranty is the writer assurance for the customer that during their particular
period if any problem found in the repairing cost will paid their particular period if any problem
found in the car, the repairing cost will paid by the seller. So the buyer is ready to give high price
for the good cars. This is the condition of Separating Equilibrium which differentiate the market of
bad and good cars.

A poor buyer who has less cost searching and less reservation price will go less
number to shops.

Moral Hazard

In fact, very few good cars owner want to give extended warranty at the time of selling. It has two reasons:
First, the problem of moral hazard. When the buyer wants the cost of car with own responsibility, then
moral lizard felt. When a seller sells the car with a warranty, then the new owner drives the car without
caring (Responsibility), because he knows that the all repairing costs have to be paid by the seller. That
is why any seller does not want to give any type of warranty to the customer.
Second, the problems to implement the warranty. After taking warranty the seller is not easily available
to customer and the customer can’t pay bills for repairing. The seller can refuse the claim for money on
the argument of negligence in case of the car.

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