Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 17: Problem 2

Cary is a recent college graduate, After six months at his new job, he has finally saved enough to buy his first car. a. Gary knows very little about the difference between makes and models. How could he use market signals, reputation, or standardization to make comparisons? b. You are a loan officer in a bank. After selecting a car, Gary comes to you seeking a loan. Because he has only recently graduated, he does not have a long credit history. Nonetheless, the bank has a long history of financing cars for recent college graduates. Is this information useful in Gary's case? If so, how?

Short Answer

Expert verified
a. Gary can use market signals (pricing), reputation (consumer reviews, ratings), and standardisation (common features) to compare different cars. b. Despite Gary's short credit history, the bank's experience with recent college graduates could be of use. They may offer him a loan with conditions to manage the risk such as higher interest rates or insurance, based on their past data of dealing with similar customers.

Step by step solution

01

Understanding Gary's options

Gary can use market signals, reputation, or standardization to make comparisons. Market signals here refer to pricing. If the car is priced higher, it generally indicates that the market perceives it to have greater value. Reputation refers to the reliability of the car make and model. He can look for consumer reviews or ratings online to understand this. Standardization refers to the common and regular features provided in a car. Cars that have more standardized features may be attractive to Gary as he lacks in-depth knowledge about different makes and models.
02

The Bank's Perspective

As a bank loan officer, Gary's short credit history might seem problematic. However, the bank has had repeated dealings with similar cases. The long history of financing cars for recent college graduates could be useful in this case. This historical data is an assurance that recent graduates have the capability to repay car loans. Although Gary does not have a long individual credit history, this group data improves his credibility.
03

Possible actions by the bank

Based on the bank's experience, the loan officer can provide a loan to Gary with some conditions to mitigate possible risks. This could include higher interest rates or mandatory insurance. The bank might also define a pre-set limit on the loan amount based on its analysis of repayment capacity of recent graduates. These measures will ensure that Gary is able to make his loan payments and the bank protects its interests.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

To promote competition and consumer welfare, the Federal Trade Commission requires firms to advertise truthfully. How does truth in advertising promote competition? Why would a market be less competitive if firms advertised deceptively?

You have seen how asymmetric information can reduce the average quality of products sold in a market, as low-quality products drive out high-quality products. For those markets in which asymmetric information is prevalent, would you agree or disagree with each of the following? Explain briefly: a. The government should subsidize Consumer Reports. b. The government should impose quality standards e.g.r, firms should not be allowed to sell low-quality items. c. The producer of a high-quality good will probably want to offer an extensive warranty. d. The government should require all firms to offer extensive warranties.

Two used car dealerships compete side by side on a main road. The first, Harry's Cars, always sells high quality cars that it carefully inspects and, if necessary, services. On average, it costs Harry's \(\$ 8000\) to buy and service each car that it sells. The second dealership, Lew's Motors, always sells lower-quality cars. On average, it costs Lew's only \(\$ 5000\) for each car that it sells. If consumers knew the quality of the used cars they were buying, they would pay \(\$ 10,000\) on average for Harry's cars and only \(\$ 7000\) on average for Lew's cars. Without more information, consumers do not know the quality of each dealership's cars. In this case, they would figure that they have a \(50-50\) chance of ending up with a high-quality car and are thus willing to pay \(\$ 8500\) for a car. Harry has an idea: He will offer a bumper-to bumper warranty for all cars that he sells. He knows that a warranty lasting \(Y\) years will cost \(\$ 500 Y\) on average, and he also knows that if Lew tries to offer the same warranty, it will cost Lew \(\$ 1000 Y\) on average. a. Suppose Harry offers a one-year warranty on all of the cars he sells. i. What is Lew's profit if he does not offer a oneyear warranty? If he does offer a one-year warranty? ii. What is Harry's profit if Lew does not offer a one-year warranty? If he does offer a one-year warranty? iii. Will Lew's match Harry's one-year warranty? iv. Is it a good idea for Harry to offer a one-year warranty? b. What if Harry offers a two-year warranty? Will this offer generate a credible signal of quality? What about a three-year warranty? c. If you were advising Harry, how long a warranty would you urge him to offer? Explain why.

UNIVERSAL SAVINGS \& LOAN has \(\$ 1000\) to lend. Risk-free loans will be paid back in full next year with \(4 \%\) interest. Risky loans have a \(20 \%\) chance of defaulting (paying back nothing) and an \(80 \%\) chance of paying back in full with \(30 \%\) interest. a. How much profit can the lending institution expect to earn? Show that the expected profits are the same whether the lending institution makes risky or riskfree loans. b. Now suppose that the lending institution knows that the government will "bail out" UNIVERSAL if there is a default (paying back the original \(\$ 1000\) ). What type of loans will the lending institution choose to make? What is the expected cost to the government? c. Suppose that the lending institution doesn't know for sure that there will be a bail out, but one will occur with probability \(P\), For what values of \(P\) will the lending institution make risky loans?

Many consumers view a well-known brand name as a signal of quality and will pay more for a brand-name product (e.g., Bayer aspirin instead of generic aspirin, or Birds Eye frozen vegetables instead of the supermarket's own brand). Can a brand name provide a useful signal of quality? Why or why not?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free