1. (Mankiw 1986) Consider the model of Mankiw (1986) discussed in the lecture. Suppose that all projects have the same expected return R so that the PiRi = R. Assume further that Pi s distributed uniformly on [ 3 /8 , 5/ 8 ].that level of required rate of return for banks, P= 5 /4 ; and that R = 3/2

(a) What is the expected repayment probability function, (r)?

(b) What is the level of loans in equilibrium?

(c) What is the equilibrium if government reduced the rate of return = 9/8

(d) Does the subsidy improve welfare ?

(e) Now suppose that that Pi s distributed uniformly on [ 1 /4 , 3 /4 ].that level of required rate of return for banks,P = 5 /4 ; and that R = 3 /2

(f) Now suppose that that Pi s distributed uniformly on [ 1 /4 , 3 /4 ].that level of required rate of return for banks, P = 9 /8 ; and that R = 3 /2