Ram has decided to retire. Ali is a lender from a neighboring village who decides to offer loans in Bagli. However, sinc
Posted: Wed Mar 09, 2022 8:26 am
Ram has decided to retire. Ali is a lender from a neighboring village who decides to offer loans in Bagli. However, since he is from a different village,he does not know the farmers in Bagli. He only knows that 80% of the farmers are SAFE and 20% are RISKY. As a result, he has to charge a single interest rate to everybody who wants a loan. Like Ram, Ali’s opportunity cost is also 25%.
(a) What type of asymmetric information problem does Ali face?
(b) What is the maximum interest rate Ali can charge so that both types of farmers would want to borrow?
(c) Let pi be Ali’s profit. Derive an expression for E(pi), the expected value of Ali’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 Ali cannot tell to which type of farmer she has given the loan!).
(d) Explain what will happen if Ali increases the interest rate above the interest rate you identified in (b)?
(e) What is the maximum interest rate Ali can charge so that at least one type of farmer will want a loan?
(a) What type of asymmetric information problem does Ali face?
(b) What is the maximum interest rate Ali can charge so that both types of farmers would want to borrow?
(c) Let pi be Ali’s profit. Derive an expression for E(pi), the expected value of Ali’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 Ali cannot tell to which type of farmer she has given the loan!).
(d) Explain what will happen if Ali increases the interest rate above the interest rate you identified in (b)?
(e) What is the maximum interest rate Ali can charge so that at least one type of farmer will want a loan?