Question

A large number of independent loan prospects are available, each paying a net return (on $100) of $16 with probability 1/2 and $2 with probability 1/2. There are as many savers as loans, each with $100. Each saver in the economy derives Happiness (H) from income (I) according to :

H= (square route) I

There is competition between intermediaries and each costs--including "normal" profits--of $1.00 on every $100 invested. What return will intermediaries pay? Why? At this rate will they attract savers away from "going-at-it-alone-" from lending directly, with each saver making a single loan? How do you know? What is the gain in happiness per saver from the existence of intermediaries? If there were a single intermediary with no competition, what return would the intermediary seeking maximum proffit offer? Explain

Answer 1