Suppose a credit market with good borrowers and 1−a bad borrower. The good borrowers are all identical and always repay their loans. Bad borrowers never repay their loans. Banks issue deposits 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, which is an asset that is worth A units of future consumption goods in the future period. Determine the interest rate on loans made by banks. How will the interest rate change if each borrower has more collateral?

Suppose a credit market with good borrowers and 1−a bad borrower. The good borrowers are all identical and always repay their loans. Bad borrowers never repay their loans. Banks issue deposits 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, which is an asset that is worth A units of future consumption goods in the future period. Determine the interest rate on loans made by banks. How will the interest rate change if each borrower has more collateral?

Economics Today and Tomorrow, Student Edition

1st Edition

ISBN:9780078747663

Author:McGraw-Hill

Publisher:McGraw-Hill

Chapter6: Saving And Investing

Section: Chapter Questions

Problem 26AA

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