Discrimination in Lending. Imagine a community where the majority discriminates

Question

Discrimination in Lending.

Imagine a community where the majority discriminates against a
minority population. The minority population is 15% of the total. Now consider a simple
model of lending with four different sets of assumptions. Two possible assumptions are that
the loan market does or does not clear. Each of these may be paired with the assumption
that prejudice is weak or strong.

Lenders with weak prejudice decline to lend to a qualified minority borrower only if forced
to choose between the minority and an equally qualified majority borrower. Lenders with
strong prejudice will never lend to a minority borrower. In the case of strong prejudice,
assume that when it exists it applies to 80% of lenders, but that the remaining 20% of
lenders have only weak prejudice. The shortage of loans when the market does not clear is
25%.

For each of the four possible assumption pairs, (market clears or not; prejudice strong or
weak) indicate the percentage of qualified minorities that receives a loan. Does the
percentage depend on whether the loan market clears? Does it depend on which assumption
we make regarding prejudice? Ans. No. Explain. Why might the loan market fail to clear? If
the market doesn’t clear, what fraction of qualified majority applicants gets denied? Ans. 2/17. Explain.

Explanation / Answer

Cases

1) strong prejudice, market clears : 20% will lend to a minority but with 85% majority, 80% get loans from strongly prejudiced, 5% majority get loans from weakly prejudiced and the remaining 15% minority also get loans from the weakly prejudiced. Hence 100% of minority get loans.

2) strong prejudice, market does clear: only 75% loans disbursed = 60% strongly prejudiced + 15% weak prejudice

60% strong prejudice give completely to majority, after which 25% majority remains unserved of whom 15% get loans from weakly prejudiced, and the minority do not get loans.

3) weak prejudice, market clears : All 15% minority get loans after the 85% majority served.

4) weak prejudice, market does not clear : Since 25% shortage, all the minority and 10% majority miss out on loans whereas 75% majority get loans.

The percentage depends on market clearing since if the market does not clear, no minority gets a loan.

If
the market doesn’t clear, what fraction of qualified majority applicants gets denied?

If the market does not clear, all the minority will get denied since they will be the first to absorb the 25% shortfall.

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