An asymmetric information problem arises when
A) interest rates exceed r.
B) the representative firm is unable to borrow.
C) there are more bad firms than good firms that wish to borrow.
D) the lender is not able to distinguish between a good borrower and a bad borrower.
E) the managers of bad firms consumer the borrowed funds as executive compensation.

Question

Quizplus · Accepted Answer

Asymmetric information occurs when one party in an economic transaction (in this case, the lender) has more information than the other party (the borrower). In this scenario, the lender is unable to distinguish between a good borrower and a bad borrower, leading to an asymmetric information problem. This can lead to adverse selection, where bad borrowers are more likely to be selected for loans, and moral hazard, where bad borrowers may take on riskier projects knowing that the lender will bear some of the risk.

An Asymmetric Information Problem Arises When