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Suppose there is one depositor who earns an income of $100 in each period.She spends $50 for consumption and the remainder goes to her savings account.Assume that a bank doesn't do anything with this money except safeguards it.The bank charges $5 for safeguarding fee.
-Assume that there is a merchant who needs $100 to open a shop at t = 0.There are five depositors.The shop can generate a cash flow of $130 at t = 2.The bank charges the merchant a loan rate of 18%.However, due to moral hazard, the merchant must be monitored, and this costs $3.The merchant will
A)borrow directly from the depositors since his expected payoff is $9 compared to borrowing from the bank which gives him an expected payoff of $6
B)borrow directly from the depositors since his expected payoff is $6 compared to borrowing from the bank which gives him an expected payoff of $9
C)borrow from the bank since his expected payoff is $9 compared to borrowing directly from the depositors which gives him an expected payoff of $6
D)borrow from the bank since his expected payoff is $6 compared to borrowing directly from the depositors which gives him an expected payoff of $9
E)not open his shop since his expected payoff is negative

Question

Use the following information for questions 
Suppose there is one depositor who earns an income of $100 in each period.She spends $50 for consumption and the remainder goes to her savings account.Assume that a bank doesn't do anything with this money except safeguards it.The bank charges $5 for safeguarding fee.
-Assume that there is a merchant who needs $100 to open a shop at t = 0.There are five depositors.The shop can generate a cash flow of $130 at t = 2.The bank charges the merchant a loan rate of 18%.However, due to moral hazard, the merchant must be monitored, and this costs $3.The merchant will
A)borrow directly from the depositors since his expected payoff is $9 compared to borrowing from the bank which gives him an expected payoff of $6
B)borrow directly from the depositors since his expected payoff is $6 compared to borrowing from the bank which gives him an expected payoff of $9
C)borrow from the bank since his expected payoff is $9 compared to borrowing directly from the depositors which gives him an expected payoff of $6
D)borrow from the bank since his expected payoff is $6 compared to borrowing directly from the depositors which gives him an expected payoff of $9
E)not open his shop since his expected payoff is negative

Quizplus · Accepted Answer

The merchant's expected payoff from borrowing from the bank is higher ($9) compared to borrowing directly from depositors ($6), making borrowing from the bank the preferable option. This takes into account the loan rate, monitoring costs, and the generated cash flow.

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