Chapter 2
2. Yes, I should take out the loan, because I will be better off as a result of doing so. My interest payment will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will be ahead of the game by $5,500. Since Larry's loan-sharking business can make some people better off, as in this example, loan sharking may have social benefits. (One argument against legalizing loan sharking, however, is that it is frequently a violent activity.)
3. Yes, because the absence of financial markets means that funds cannot be channeled to people who have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses that would help the economy grow rapidly.
7. Because you know your family member better than a stranger, you know more about the borrower's honesty, propensity for risk taking, and other traits.
English: The New York Stock Exchange on Wall Stree...
New York Stock Exchange on Wall Street in New York...
English: New York Stock Exchange on Wall Street, N...There is less asymmetric information than with a stranger and less likelihood of an adverse selection problem, with the result that you are more likely to lend to the family member.
10. They might not work hard enough while you are not looking or may steal or commit fraud.
11. Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the loan, you must still stop the borrower from doing so. Because that may be costly, you may not spend the time and effort to reduce moral hazard, and so moral hazard remains a problem.
12. True. If there are no information or transaction costs, people could make loans to each other at no cost and would thus have no need for financial intermediaries.
Chapter 7
1. Financial intermediaries can take advantage of economies of scale and thus lower transaction costs. For...