Exercise \(\PageIndex{1}\)
Given the following:
Profits of falsely claiming high quality with no signal are 120.
Profits of truthfully claiming high quality with no signal are 100.
Profits of truthfully claiming low quality are 80.
The cost of a true signal of high quality is 16.
The cost of a false signal of high quality is 38.
(1) Is truthful access to the high-quality market profitable given the signal?
(2) Does the signal remove the incentive of high-quality firms to cheat?
(3) Does the signal remove the incentive of low-quality firms to deceive?
(4) Is there a separating equilibrium that corrects the lemons market?
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Answer
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Answer for (1): Yes
Answer for (2): Yes
Answer for (3): No
There is a separating equilibrium if all answers are 'Yes'