Question

Carlos is risk-neutral and has an ancient farmhouse with great character for sale in Slaterville Springs. His reservation price for the house is $130,000. The only possible local buyer is Whitney, whose reservation price for the house is $150,000. The only other houses on the market are modern ranch houses that sell for $125,000, which is exactly equal to each potential buyer’s reservation price for such a house. Suppose that if Carlos does not hire a realtor, Whitney will learn from her neighbor that Carlos’s house is for sale and will buy it for $140,000. However, if Carlos hires a realtor, he knows that the realtor will put him in touch with an enthusiast for old farmhouses who is willing to pay up to $350,000 for the house. Carlos also knows that if he and this person negotiate, they will agree on a price of $300,000.

Answer 1

Answer:

The question is not complete, this part could complete the question:

"If Realtors charge a commission of 5 percent of the selling price and all Realtors have opportunity costs of $2,000 for negotiating a sale, will Carlos hire a Realtor? If so, how will total economic surplus be affected?"

The answer is, the total economic surplus increased from $20,000 to $248,000

Explanation:

Firstly it is important to understand what marginal cost, marginal benefit and Asymmetric information is. Marginal cost is the cost added from the spending of one more unit of resource while marginal benefit is considered as the benefit from spending one more unit of resource. Asymmetric information is a situation whereby one part of the transaction possess more information and material facts than other parts.

Carlos reservation price is $130,000. He wishes to sell to sell for $140,000 to Whitney who has a reservation price of $150,000. Therefore the surplus to Carlos is 140,000 - 130,000 = $10,000 and surplus to Whitney is 150,000 - 140,000 = $10,000. Therefore, the total economic surplus is $20,000

If Carlos sells through a realtor who charges 5% if the property is sold for $300,000 to someone with a reservation price of $350,000. The surplus will be:

5% × 300,000 - 2000 = $13,000.

Now, the surplus is 300,000 - 130,000 + 15,000 = $185,000

Therefore, the surplus to the buyer is

350,000 - 300,000 = $50,000

Hence, the total economic surplus increased from $20,000 to $248,000