Assignment 6 – Market value vs accounting value

Ralph Inc. wants to purchase a used car from FF (a Friendly Firm). The car has private value to
FF denoted v. FF knows v; Ralph only knows v is uniformly distributed between v = 0 and v =
300.000. FF knows this about Ralph. Finally, whatever v is, the value of the car to Ralph is
1.4v (Ralph could really use that car!). FF also knows this about Ralph.

(a) Who should own the car, Ralph or FF from an economics perspective?

(b) Suppose the trade encounter between the two firms proceeds as follows. Ralph offers
to purchase the car at price P. If FF agrees, Ralph pays P in exchange for the car. If FF
does not agree, the game ends, and FF keeps the car. Now, from Ralph’s perspective,
what is the expected value (to Ralph) of the car, before any conversation with FF?
Conversely, suppose Ralph offers price P > 0 and FF accepts the offer; what now is the
expected value (to Ralph) of the car?

(c) What is the equilibrium in this game? Why does no trade take place, despite the fact
Ralph is known to value the object higher than the Friendly Firm?

(d) Suppose Ralph has acquired the car in the stated negotiations at price P. You are the
accountant in Ralph Inc. How would you record the newly acquired asset in the books of
Ralph Inc? Would you have any second thoughts to add to the financials? Explain in a
short paragraph the paradox (if any) you are facing.

(e) Now suppose that the value is uniformly distributed between v =200.000 and v =
300.000. What is the optimal bid for Ralph in this case? What are the consequences of
this for your answers to a, b, c, and d of this new assumption? Explain briefly.

(f) Now suppose that the value is uniformly distributed between v =20.000 and v =
300.000. What is the optimal bid for Ralph in this case? What are the consequences of
this for your answers to a, b, c, and d of this new assumption? Explain briefly.

(g) Would the answers to a, b, c, and d be the same if neither of the two parties knew the
value of the car prior to bargaining? Again explain briefly, no calculations are required.