Econ 3020 Macroeconomics theory chapter 10

Suppose the Canadian credit market has a proportion of good borrowers and (1 a) bad borrowers. The good borrowers are all identical and always repay their loans. Bad borrowers never repay their loans. Banks issue deposits L, that pay a real interest rate r , and make loans to borrowers. Banks cannot tell the difference between a good borrower and a bad one. Each borrower has collateral that is worth A units in the future

- Answer the following

1. Determine the interest rate on loans made by banks

2. How will the interest rate on loans change if each borrower has more collateral?

3. Assume r is 1%, and that 30% of borrowers are likely to default due to inflation. Also assume L = $1million and A = $300,000. Find the interest rate on loans.