Chapter 8. Adverse Selection

15.

After moving, you try to find a new dentist. Why might you want to make an appointment only with a dentist who couldn’t schedule you in for at least several months?

16.

You put $100 in nine envelopes and nothing in the 10th envelope. The envelopes are shuffled. Debbie picks one envelope at random and examines its contents. Jim offers to buy the envelope Debbie picked for some amount of money that Jim chooses. When Jim makes his offer, he does not know what is in Debbie’s envelope. Debbie either accepts Jim’s offer or rejects the offer and keeps the envelope. How much should Jim offer to buy Debbie’s envelope for?

17.

You want to buy a car, but you are unsure of its value. You estimate that it is equally likely that the car is of high quality or it’s junk. The seller knows the car’s quality. The following gives the value of the car to both you and the seller.

Car’s Quality	Value To You	Value to Seller
High	$10,000	$6,000
Junk	$0

In the game you make an offer to buy the car. If the offer is rejected, the game ends. Even though there is a 50 percent chance that the car is of high quality, you should still not offer to pay anything for it. Why?

Answers

15.	A patient should most want to see a dentist who pleases his current patients and as a result continually gets repeat and new customers. Such a dentist would necessarily have a long waiting list for new patients. A bad dentist who quickly lost customers would have a lot of free time available. The type of dentist who could schedule you for the earliest appointment might be the type whom you should least trust to put sharp instruments in your mouth.
16.	Jim should offer to buy the envelope for $0. If Jim offered to buy the envelope for any positive amount less than $100, Debbie would accept only if the envelope was empty. For example, if Jim offered to buy the envelope for $5, Debbie would take the $5 if the envelope was empty and reject the money if it had $100. Thus, Jim is better off offering $0 than $5.
17.	If you offer to buy the car for less than $6,000 the seller will always reject your offer if the car is of high quality. So, for example, if you offer to buy the car for $200, 50 percent of the time your offer will be rejected, and 50 percent of the time it will be accepted, but you will have paid $200 for worthless junk. Consequently, you never want to offer a positive amount less than $6,000. If you pay $6,000 or more, then you will get a high-quality car only one-half of the time. Thus, one-half of the time you get something worth $10,000, and one-half of the time you get junk, giving you on average something worth $5,000. You shouldn’t pay $6,000 or more for something worth on average only $5,000.