The market for used cars is shown in the above figure. Buyers cannot tell whether any given car is a lemon. For all cars offered for sale to be sold, the percent of all cars that are lemons is ?

What happens to ? if car buyers incur a $100 transaction cost when buying a used car?

The sellers of good cars have a reservation price of $1,800. Setting $1,800 equal to the expected value of a car yields 1800 = (? ? 1,000 ) + ((1 - ?) ? 2,000 ) = 2,000 - (? ? 1,000 ). So ? = 20%. If a $100 transaction cost is incurred then set 1800 = (? ? 1,000 ) + ((1 - ?) ? 2,000 ) - 100. This yields ? equals 10%. If buyers incur a transaction cost, their net expected value of a car purchase declines. The probability of a car being a lemon must decline to keep the price above the reservation price of sellers of good cars.