Many wineries of Napa region of California have strong reputations for producing high-quality wines and want to protect those reputations.  According to some Napa wineries, Fred T. Franzia, the owner of Bronco Wine Co., possibly could harm those reputations.  Mr. Franzia sells Napa-brand wines that do not contain Napa grapes (Julia Flynn, “In Napa Valley, Winemaker’s Brands Divide an Industry,” Wall Street Journal, February 22, 2005, A1).  The other Napa wineries that are involved in legal disputes with Mr. Franzia contend that his wines, made from lower-quality grapes, are damaging the reputation of the Napa wines.  Use the analysis in Section 19.3 to answer the following questions.  The wine market in this problem has 2,000 wineries, in which each chooses to sell one bottle of wine.  One thousand of the wineries have Napa grapes and can choose to turn the grapes into wine, and 1,000 wineries have Central Valley grapes and can turn those grapes into wine.  The marginal opportunity cost of selling a Napa wine is $20 and the marginal opportunity cost of selling a Central Valley wine is $5.  A large number of risk-neutral consumers with identical tastes are willing to buy an unlimited number of bottles at their expected valuations.  Each consumer values a wine made from Napa grapes at $25 and values a wine made from Central Valley grapes at $10.  By looking at the bottles, the consumers cannot distinguish between the Napa and the Central Valley wines. 

 

a. If all of the wineries choose to sell wine, what is a consumer’s expected value of the wine?  If only the wineries with Central Valley grapes choose to sell wine, what is a consumer’s expected value of the wine?

b. What is the market equilibrium price?  In the market equilibrium, which wineries choose to sell wine?

c. Suppose wine bottles clearly label where the grapes are grown.  What are the equilibrium price and quantity of Napa wine?  What are the equilibrium price and quantity of wine made from Central Valley grapes?

d. Does the market equilibrium exhibit a lemons problem?  Include an analysis of whether clearly labeling the origin of the grapes solves the lemons problem.