Calculate the expected return from each technique

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Reference no: EM13185970

Sua suppose a farmer has some money of his own to invest in a better way to cultivate his land. there are two techniques, both of which require an initial start-up capital of $200. The first technique is risk free and generates a return of 20% while the second technique is new and riskier but generates a return of 50% if successful but nothing if it fails. There is a 60% probability of success using the second technique.

A) Calculate the expected return from each technique for the farmer to determine which technique the farmer will choose to adopt.

Now suppose the farmer does not have any money of his own and has to turn to the village money lender who lends to borrowers on a repeated basis. Assume that the interest rate that the money charges is fixed at 10%. The loans are informal and are not backed up by written contracts. The lender has no way to recover a loan if the borrower chooses to default. The lender, however, threatens to cut off credit in the future to any defaulting borrower.

B) Now calculate the expected return from each technique from the farmer's perspective to determine which technique the farmer will choose.

C) Is this problem an example of the concept of adverse selection or moral hazard? Explain.

Reference no: EM13185970

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