2. Ainu and Beatriu are savers who each have $100 to lend to Somerset Corp. Ainu and Beatriu, however, can determine Somerset’s project only by doing research. The cost of research is $6, and lenders cannot cooperate to share the cost of research. Ainu and Beatriu know that half of firms have the safe project and half the risky (inefficient) project. A safe project is risk free and costs $200 and is guaranteed to deliver $220. The full surplus from the project accrues to the lenders. The risk-free rate is 3 percent. Assume that everyone is risk neutral and that each saver can observe how the other lends.

 

1. How much is an individual saver’s expected payoff, net of research costs, from doing research?

 

2. What’s the maximum that an individual is willing to spend on research?

 

3. In equilibrium, who, if anyone, does research? Explain. How much is the expected value of the equilibrium deadweight loss?

 

4. Suppose that instead of lending directly to Somerset, Beatriu and Ainu deposit their funds in a commercial bank, which pays them the cost of funds. How much is the commercial bank’s willingness-to-pay for research? Explain why the WTP differs from the answer in part b).

 

5. Assume now that each saver can NOT observe how the other lends. Find the range of feasible prices for (post-research) information.