Raj has decided to retire. His grandson, Isaac, will be the new lender in the village....
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Raj has decided to retire. His grandson, Isaac, will be the new lender in the village. Isaac has lived his whole life in the big city and does not know the farmers in the village of Yolo-land. Isaac only knows that 70% of the farmers are SAFE and 30% are RISKY. As a result, he has to charge a single interest rate to everybody who wants a loan. Like Raj, in order to offer a loan, Isaac must withdraw $100 from his savings account, where he earns an interest rate of 15%. He is also a monopolist who offers the same type of limited liability loans that Raj offered (fully repay under good harvest; repay 0% of the total debt obligation if harvest is bad). a. What type of asymmetric information problem does Isaac face? Write a short explanation justifying your answer. b. What is the maximum interest rate Isaac can charge so that both types of farmers would want to borrow? c. Let be Isaac's profit. Derive an expression for E(), the expected value of Isaacs's profit from a loan, as a function of the interest rate when the interest rate is less than or equal to the value you identified in part b. (Remember: Over this range of the interest rate, Isaac cannot tell to which type of farmer he has given the loan!). d. Explain what will happen if Isaac increases the interest rate above the interest rate you identified in b? e. What is the maximum interest rate Isaac can charge so that at least one type of farmer will want a loan? f. Derive an expression for Isaac's expected profit, E(), as a function of the interest rate for values between the interest rates you identified in part b and part e. g. What will happen if Isaac increases the interest rate above the interest rate you identified in part e? h. Use the expressions from parts c and f to graph Isaac's expected profit as a function of the interest rate for interest rates between 0 and 3. Label this graph "Figure 4. Lender's Expected Profit under Asymmetric Information" and insert it in the box below. i. What is the equilibrium interest rate charged by Isaac? j. What is Isaac's expected profit? 13 k. Which type or types of farmers take the loan? 1. For the type(s) of farmer(s) identified in (k), find the expected income. m. Under symmetric information, a monopolist lender will drive the expected income of the borrower(s) to zero. Based on your answer to part 1, is that still the case for a monopolist under asymmetric information? Raj has decided to retire. His grandson, Isaac, will be the new lender in the village. Isaac has lived his whole life in the big city and does not know the farmers in the village of Yolo-land. Isaac only knows that 70% of the farmers are SAFE and 30% are RISKY. As a result, he has to charge a single interest rate to everybody who wants a loan. Like Raj, in order to offer a loan, Isaac must withdraw $100 from his savings account, where he earns an interest rate of 15%. He is also a monopolist who offers the same type of limited liability loans that Raj offered (fully repay under good harvest; repay 0% of the total debt obligation if harvest is bad). a. What type of asymmetric information problem does Isaac face? Write a short explanation justifying your answer. b. What is the maximum interest rate Isaac can charge so that both types of farmers would want to borrow? c. Let be Isaac's profit. Derive an expression for E(), the expected value of Isaacs's profit from a loan, as a function of the interest rate when the interest rate is less than or equal to the value you identified in part b. (Remember: Over this range of the interest rate, Isaac cannot tell to which type of farmer he has given the loan!). d. Explain what will happen if Isaac increases the interest rate above the interest rate you identified in b? e. What is the maximum interest rate Isaac can charge so that at least one type of farmer will want a loan? f. Derive an expression for Isaac's expected profit, E(), as a function of the interest rate for values between the interest rates you identified in part b and part e. g. What will happen if Isaac increases the interest rate above the interest rate you identified in part e? h. Use the expressions from parts c and f to graph Isaac's expected profit as a function of the interest rate for interest rates between 0 and 3. Label this graph "Figure 4. Lender's Expected Profit under Asymmetric Information" and insert it in the box below. i. What is the equilibrium interest rate charged by Isaac? j. What is Isaac's expected profit? 13 k. Which type or types of farmers take the loan? 1. For the type(s) of farmer(s) identified in (k), find the expected income. m. Under symmetric information, a monopolist lender will drive the expected income of the borrower(s) to zero. Based on your answer to part 1, is that still the case for a monopolist under asymmetric information?
Expert Answer:
Related Book For
Posted Date:
Students also viewed these economics questions
-
kindly elaborate: standard for accounting policies, methods and procedures. thanks
-
Sun Corporation received a charter that authorized the issuance of 108,000 shares of $7 par common stock and 20,000 shares of $100 par, 6 percent cumulative preferred stock. Sun Corporation completed...
-
Use this information about Mocha Company to answer the question that follows. Mocha Company manufactures a single product by a continuous process, involving three production departments. The records...
-
Bilge Pumpworks and Seaworthy Rope Company agreed to merge on January 1, 20X3. On the date of the merger agreement, the companies reported the following data: Bilge Pumpworks has 10,000 shares of its...
-
Assume that Thailand and India are potential trading partners of China. Thailand is a member of ASEAN but India is not. Suppose the import price of textiles from India (PIndia) is 50 per unit under...
-
Explain how an activity-based costing system operates.
-
Defective units decision analysis Claymore Manufacturing Company produces auto- mobile stereo systems in job lots. Production errors occasionally occur, and defective units are reworked if it can be...
-
Gretta Chung Associates surveys American eating habits. The companys accounts include Land, Buildings, Office Equipment, and Communication Equipment, with a separate Accumulated Depreciation account...
-
The graph of fis shown. y = f(x) 4 0 X 4 8 12 16 Hint: What is the area of each square? a) So f (x) dac = b) So f (2 ) dac c ) Sid f ( ze ) dac d) So f (a) dac = e) So If (ae) | dac
-
If y = 1-x 1 + x " then prove that (1-x) dy + y = 0. dx (2020, 18)
-
Roberts Company is considering an investment in equipment that is capable of producing more efficiently than the current technology. The outlay required is $2,233,333.The equipment is expected to...
-
Write a complete C++ program that takes 10 integers from the user and stores them in an array by using a for loop. The program should find the sum of the integers at even indexes (including index 0),...
-
Your clients, Mike and May, have inherited $250,000 cash from May's aunty and they would like to invest it with your help. They consider themselves fairly conservative investors and are also...
-
Student excuses are getting more sophisticated, but so are the investigative tactics of teachers. Adrian Lee is the digital editor of Maclean's magazine; he also prides himself on being its resident...
-
Consider the following linear trend models estimated from 10 years of quarterly data with and without seasonal dummy variables d 1 , d 2 , and d 3 . Here, d 1 = 1 for quarter 1, 0 otherwise; other...
-
for accounting Inventory by Three Methods The units of an item available for sale during the year were as follows: Jan.1 Inventory 25 units at $200 per unit Feb. 19 Purchase 56 units at $230 per unit...
-
If a test has high reliability. O the test measures what the authors of the test claim it measures O people who take the same test twice get approximately the same scores both times O scores on the...
-
Revise sales budget (Learning Objective 4)} Turn to the original Whitewater Sporting Goods Data Set item 3. Suppose June sales are expected to be \(\$ 40,000\) rather than \(\$ 60,000\). Revise...
-
Continuation of S10-5: cash budget (Learning Objective 3) Refer to \(\$ 10-5\). Grippers has \(\$ 8,300\) cash on hand on January 1. The company requires a minimum cash balance of \(\$ 7,500\)....
-
Interpret favorable variance (Learning Objective 5) Exhibit 10-20 shows that the Mexican sauces product line had a favorable marketing expense variance. Does this favorable variance necessarily mean...
Study smarter with the SolutionInn App