An asymmetric information problem arises when
A)the representative firm is unable to borrow.
B)there are more bad firms than good firms that wish to borrow.
C)interest rates exceed r.
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 problem arises when the lender is not able to distinguish between a good borrower and a bad borrower. This creates a situation where the lender may end up lending to bad borrowers who have a higher probability of defaulting, causing financial losses to the lender. This problem can lead to credit rationing, where even good borrowers are unable to get loans because lenders are wary of lending to anyone.

An Asymmetric Information Problem Arises When