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 a transaction has more information than the other party. In the case of borrowing, the lender may not be able to distinguish between a good borrower and a bad borrower, leading to an asymmetric information problem. This can result in adverse selection, where borrowers who are more likely to default are more likely to seek out loans, or moral hazard, where borrowers who receive the loan may take on riskier investments because they do not bear the full cost of failure.

An Asymmetric Information Problem Arises When