4. Consider the Diamond-Dybvig model of banks that offer deposit facilities to risk averse consumers who do not yet know whether they want to consume 'early' or 'late'.

a) Illustrate the deposit contract offered by competitive banks and discuss in what sense it provides insurance to consumers. Could banks provide this insurance if consumers knew their consumption preferences with certainty before depositing funds, but banks did not?

b) Explain why a bank run is also an equilibrium in this model.

c) Discuss how government deposit insurance rules out the bank run equilibrium and comment on the fiscal cost of providing this insurance.