1. 

a. False. The information imparted by the expense of the advertisement, not the message itself, is the more reliable signal of high quality. The produce of a product who knew that consumers would be unlikely to buy its product a second time would gain little by spending millions to induce them to try it.

b. True. Because charging non-buyers for advice is often impractical, the market generally provides less than the socially optimal amount of retail service.

c. False. The best-attired lawyer will not always be the best lawyer. You should follow this selection strategy only when you have no more reliable information about the quality of the lawyers.

d. True. The benefit of searching in a large city is greater, because there is a greater range of potential spouses to choose from.

2. Since consumers value nondefective cars at $10,000, the only used cars for sale will be defective ones. The used car price of $2,500 is thus the value to consumers of a defective car. For a risk-neutral buyer, the reservation price for a new car will be the value of a good car times the probability of getting a good car, plus the vale of a bad car times the probability of getting a bad car. To find x, we thus solve:

$5,000 = (1-x)($10,000)+x($2500) 

3.

a. Comparing the VMP table with the table of marginal labor cost, it is apparent that Jenny contributes a VMP of $150/wk at a marginal labor cost of $95/wk. However, Jeff contributes only $100 in VMP whereas the marginal labor cost of hiring him is $105. Therefore, Rainflower will hire Jon, Joe, Jenny and the wage will be $85/wk.

b. The socially optimal number is 4 per week. To see this, we compare the workers’ reservation wages with the corresponding VMP at each hiring level. With only three workers, the social cost of adding a fourth is that worker’s reservation wage, $90. the social benefit of hiring the fourth worker is the additional value of his output, or $100. by not adding a fourth worker, society loses a surplus of $10/week.

c. Rainflower would hire the social optimal number of four workers. The marginal labor cost for the fourth worker would now be only his reservation wage of $90, but his VMP would still be $100.

5. 

a. Carolyn will hire 3 workers. They will produce 480 cases. This follows from the fact that the value of the third worker’s marginal product is greater than the market wage ($1,000) while the VMP of the fourth worker is less.

b. Carolyn will only hire 2 workers.

c. Each VMP entry will be 50 percent larger than before, so Carolyn will now hire 4 workers.