answer 3-4 - Econ 350 Spring 2009 Answers to selected...

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Econ 350 Spring 2009 Answers to selected questions Assignments 3 – 4 ASSIGNMENT 3 1. Describe whether each of the following is an example of adverse selection or moral hazard, and why. a. When I drive a rental car, I drive much more recklessly than when I drive my own car. This is moral hazard, since some of the costs of your actions are being borne by the rental company. It occurs after the transaction, once the car has been rented. b. The sickest people are the ones most likely to sign up for health insurance. This is adverse selection, since it occurs before the transaction. The market is likely to be dominated by low-quality items, in this case sick people. Healthy people have less of an incentive to purchase health insurance to begin with. c. Weasel Wannabe took out a business loan from Firstbank to start a hot dog stand, but instead spent the money on a trip to Aruba. This is moral hazard, since FirstBank bears the costs of Weasel’s actions. d. Neighborhoods with high levels of student housing and low levels of owner-occupied housing tend to deteriorate more quickly than other neighborhoods. This is actually an example of both moral hazard and adverse selection. Adverse selection means that students are more likely to choose to live in deteriorated neighborhoods to begin with. Once students live in the neighborhood, moral hazard sets in. Since most students do not own their houses, there is less of an incentive to maintain the houses properly. The costs of neglect are mostly borne by the landlord. e. The safest borrowers are unlikely to need bank loans. This is an example of adverse selection. The converse is that the riskiest borrowers are the ones most likely to seek out loans. 2. To find the current balance sheet for all commercial banks in the United States, go to the following web site: www.federalreserve.gov/releases/h8/current . Navigation instructions are included in Class 9 notes if the link is not working. After looking at the balance sheet, please answer the following questions: a. What are the major categories of assets shown? What are the major categories of liabilities shown? Assets include loans, securities, inter-bank loans, cash, and other assets. Liabilities include transactions deposits, non-transaction deposits, liabilities, and other.
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Econ 350 Spring 2009 Answer Key to Selected Problems 3-4 2 b. What percentage of banks' assets consist of securities? Assets = 12,053.3, securities = 2669.3 so securities are 22.15% of assets. c. What percentage of banks' assets consist of loans? Assets = 12053.3,
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answer 3-4 - Econ 350 Spring 2009 Answers to selected...

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