Imagine that there are two types - high and low- of potential borrowers. Both exist in...

 

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Imagine that there are two types - high and low- of potential borrowers. Both exist in equal proportion in the population. The high type has access to a technology that generates a gross return of 2 with probability 0.8 and a gross return of 0 with probability equal to 0.2. The low type can generate a gross return of 5 with probability 0.1 and a gross return of 0 with probability equal to 0.9. Assume that commercial banks can secure a gross return of 1 by making a deposit at the FED. If a commercial bank operating in a competitive market could distinguish between the two types then it should charge a gross interest rate of O 1 to both types O 10 to the low type O 5/4 to the high type Onone of the above Imagine that there are two types - high and low- of potential borrowers. Both exist in equal proportion in the population. The high type has access to a technology that generates a gross return of 2 with probability 0.8 and a gross return of 0 with probability equal to 0.2. The low type can generate a gross return of 5 with probability 0.1 and a gross return of 0 with probability equal to 0.9. Assume that commercial banks can secure a gross return of 1 by making a deposit at the FED. If a commercial bank operating in a competitive market could distinguish between the two types then it should charge a gross interest rate of O 1 to both types O 10 to the low type O 5/4 to the high type Onone of the above

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In a competitive market where the bank can perfectly distinguish between borrower types it would not ... View the full answer