Question

Gary is a recent college graduate. After six months at his new job, he has finally saved enough to buy his first car.

a. Gary knows very little about the difference between makes and models. How could he use market signals, reputation, or standardization to make comparisons?

b. You are a loan officer in a bank. After selecting a car, Gary comes to you seeking a loan. Because he has only recently graduated, he does not have a long credit history. Nonetheless, the bank has a long history of financing cars for recent college graduates. Is this information useful in Gary’s case? If so, how?

Short answer

1. Gary’s situation is associated with asymmetric information; therefore, market signals, reputations, or standardization will help Gary differentiate between the good and bad quality cars and enable him to take an optimal decision.

1. This information is not useful on the bank’s part since the bank does not have much information about Gary. This will create the problem of asymmetric information.

Step-by-step solution

Use of market signals, reputation, or standardization 

Gary faces the problem of asymmetric information since he does not have as much knowledge about the cars in the market as the car sellers have. Market signals can help him make a difference between makes and models, as they provide quality assurance.A used car seller can use his reputation, and a new car dealer relies on the manufacturer’s guarantee. Gary can use consumer reports or expert reviews while deciding on which car to buy.

For example, Gary could use information based on the reputation of the firm. The brand establishes its identity in terms of quality or product assurance. The standard and extended warranties are used as a tool to signal the quality.Therefore, such methods will help Garry to draw comparisons between good quality and bad quality products.

Asymmetric Information for banks

The banks do not have much information about Gary and his credit history as he is a fresh graduate. They can gather information about the car he is about to buy by using market signals, but they still need to know Gary’s creditworthiness. They need to find Gary’s ability to handle and pay back the loan by checking his past credit history, educational profile, family history, and others.

However, young graduates generally do not have a good repayment profile which can hamper Gary’s chances of getting a loan.