1. Imagine there are two types of potential borrowers in a village, those with pi=0.7 and those with pi=0.9. As in the adverse selection model discussed in class, these borrowers succeed with probability pi and fail with probability (1pi). If they fail, they get no payoff and can pay nothing to the bank (i.e., there is no collateral). If they succeed, they pay back (1+ri)L to the bank. Assume that for all borrowers, L = $2000 and the expected gross payoff to borrowing (i.e. without accounting for payment to the bank) is $4000. Assume all potential borrowers have a non-borrowing option they can choose instead of borrowing: working for a subsistence wage of $1400. First consider individual lending. e. For both borrowers, what is their expected net payoff to borrowing? Which types will borrow? Justify your answer. f. In words, what is the adverse selection problem, when does it appear, and why