Suppose you go to your local bank, intending to buy a certificate of deposit with your savings. Explain why you would prefer to offering a loan, at an interest rate that is higher than the rate the bank pays on the certificate of deposit (but lower than the rate the bank charges for the car loans), to the next individual who enters the bank and applies for a car loan. Concept Introduction: Banks are more efficient in dealing with the problem of asymmetric information which leads to an adverse selection and moral hazard. Also, there are high information and transaction costs associated with solving these problems. Banks reduce these costs by pooling the funds of their customers, gaining more information, implementing restrictive covenants, etc. Thus, banks can provide various loans to a variety of customers and can reduce the problems arising due to asymmetric information.

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Chapter 8, Problem 5Q

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Suppose you go to your local bank, intending to buy a certificate of deposit with your savings. Explain why you would prefer to offering a loan, at an interest rate that is higher than the rate the bank pays on the certificate of deposit (but lower than the rate the bank charges for the car loans), to the next individual who enters the bank and applies for a car loan.

Concept Introduction:

Banks are more efficient in dealing with the problem of asymmetric information which leads to an adverse selection and moral hazard. Also, there are high information and transaction costs associated with solving these problems. Banks reduce these costs by pooling the funds of their customers, gaining more information, implementing restrictive covenants, etc. Thus, banks can provide various loans to a variety of customers and can reduce the problems arising due to asymmetric information.

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