Carfax is a web-based service that supplies vehicle history reports to individuals on used cars: ownership history, vehicle mileage, accident reports, and other information. The existence of Carfax as a third-party verifier in the used car industry can result in which of the following?
Carfax could lead to
an efficient outcome in the used car market.
a reduction in the variance in the quality of cars in the used car market.
an increase in the number of cars available in the used car market.
Decisions Involving Private Information – -End of Chapter Problem Carfax is a web-based service that supplies vehicle history reports to individuals on used cars: ownership history, vehicle mileage, accident reports, and other information. The existence of Carfax as a third-party verifier in the used car industry can result in which of the following? Carfax could lead to an efficient outcome in the used car market. a reduction in the variance in the quality of cars in the used car market. an increase in the number of cars available in the used car market.
The correct answer and explanation is:
Correct Answer:
An efficient outcome in the used car market.
Explanation:
Carfax, as a third-party service providing vehicle history reports, helps reduce information asymmetry in the used car market. Information asymmetry occurs when one party (typically the seller) has more information about the product (in this case, the car) than the other party (the buyer). This imbalance can lead to market inefficiencies, such as the “market for lemons” problem, where low-quality cars drive high-quality cars out of the market.
Carfax addresses this issue by offering buyers access to detailed and reliable information about a car’s history, such as ownership, mileage, and accidents. With this data, buyers can make better-informed decisions, improving trust in transactions. Sellers of high-quality cars also benefit, as they can demonstrate the value of their vehicles through verified reports, attracting serious buyers and often commanding better prices.
The availability of credible third-party verification reduces the likelihood of buyers purchasing low-quality cars unintentionally. This encourages the presence of higher-quality cars in the market, as sellers are incentivized to maintain vehicles well, knowing their history will be scrutinized. Consequently, Carfax contributes to the market operating more efficiently, where prices better reflect the actual value of the cars.
While Carfax indirectly impacts the other options (reducing variance in quality and potentially increasing the number of cars in the market), these outcomes are secondary to its primary effect: promoting efficiency. By ensuring that buyers and sellers have access to accurate and transparent information, Carfax minimizes adverse selection, enhances trust, and facilitates fairer transactions. This ultimately supports a more balanced and effective used car market.