A bank faces a pool of high and low risk borrowers with measure one in two successive periods. In each period, each borrower wishes to borrow 1 from the bank. A low-risk borrower's project returns G = 2 with probability pg = 0.8 and high- risk borrower's project yields B = 3 with probability p = 0.2 in each period. If a project is unsuccessful, it yields zero. The bank knows that the proportion of low-risk borrowers is y = 0.5. However, the bank is unable to distinguish between low and high-risk borrowers, i.e. it doesn't have an appropriate screening technology. Consider a bank which operates as a monopoly and wants to attract both types of borrowers in the first period.

A bank faces a pool of high and low risk borrowers with measure one in two successive periods. In each period, each borrower wishes to borrow 1 from the bank. A low-risk borrower's project returns G = 2 with probability pg = 0.8 and high- risk borrower's project yields B = 3 with probability p = 0.2 in each period. If a project is unsuccessful, it yields zero. The bank knows that the proportion of low-risk borrowers is y = 0.5. However, the bank is unable to distinguish between low and high-risk borrowers, i.e. it doesn't have an appropriate screening technology. Consider a bank which operates as a monopoly and wants to attract both types of borrowers in the first period.

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter17: Making Decisions With Uncertainty

Section: Chapter Questions

Problem 2MC

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