Question

Assume that a swindler must disgorge her profits if she gets caught.

a. In order to make swindling unprofitable (expected value of swindling equals zero), how high must the probability of getting caught be?

b. If the probability of getting caught is 20%, swindling is profitable even if swindler disgorges all profits when caught. But if we add a fine for swindling, it would create more disincentive to swindle. What should the size of the fine be to produce the efficient amount of swindling (given the probability of getting caught is 20%)?

Answer 1

Solution:

a.

The probability of getting caught will be 1 in order to make swindling unprofitable(expected value of swindling equals zero). But we know that the probability of getting caught is always smaller than 1. That explains why most forms of swindling are also crimes.

b.

The probability of getting caught is 20%.

Their expected profit is = (0.8-0.2)*Capital = 0.6*capital.

So, the fine amount should be 60% of the capital then it would create more disincentive to swindle.