Question

1. Now assume that Allen needs to borrow £300 to produce his software, which will generate £500 in two years. There are N savers in the economy, each en- dowed with £2 and each facing a 25% chance that there will be an emergency and they will need their £2 back. What is the minimum value of N such that a financial intermediary can solve the problem of getting money from savers to borrowers?

Answer 1

John needs = $300

Each person endow = $2

There is 25% (0.25)chance of using $2 while 75% (0.75) chance of not using it

Estimated amount people will keep with themselves = Money they need in case of emergency * Probability of emergency + Money they need in case there is no emergency * Probability of no emergency = 2 * 0.25 + 0 * 0.75 = 0.5

It means that per person is willing to keep $0.5 and pay $1.5 out of $2 to John which means 300 / 1.5 = 200 people are needed to solve the problem of financial intermediary.