Comment on what this exercise reveals

Reference no: EM132174809

Question: Consider the case of two borrowers who are equally productive. Borrower 1 is considered to be "rich" as she has cash equivalent to A = $50 in her pocket. Borrower 2 is considered to be "poor" as she has zero cash in her pocket. Both borrowers are interested in a project that requires an initial investment of $100. If they put forth a sufficient level of effort, they can both get a gross return y = $300 with certainty. Otherwise, both borrowers succeed with probability 0.25. The cost of exerting effort for both borrowers is c = $145. The necessary funds for financing the project may come either from borrowing or from the potential investors' own pockets. The gross cost of lending capital per dollar for a competitive bank is k = $1.50.

a. Show that only the rich borrower can invest and comment on the efficiency of this result.

b. Comment on what this exercise reveals, given the asymmetric value of financial access at different levels of wealth.

Reference no: EM132174809

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