2:29 PM a instructure-uploads.s3.amazonaws.com Problem Set 1 Base interest rate

Question

2:29 PM a instructure-uploads.s3.amazonaws.com Problem Set 1 Base interest rate T-Mobile * 44%-- I. Assume that the market interest rate is 50% (r-0.50) and that an enterprise has an initial endowment of two units. Assuming the available productive opportunity is as described in the first two columns of the table below, fill in the remainder of the table to determine the outcome for each indicated level of investment invest output borrow repay keep 3.75 3 9.75 12 13.75 15 4 6 a. How much does the enterprise choose to borrow? b. What are the gains-from-trade resulting from the opportunity to borrow? 2. Billy 's dema nd for loans is given by B 75-250 r. The market interest rate is 10%. Calculate: a. b. The amount Billy borrows, Billy's gains from trade

Explanation / Answer

1(a) The enterprise chooses to borrow 3 more units that is Investment Level 5 because they get to keep (earn) the maximum out of the entire transaction

1(b) The gains from opportunity to borrow would be 2.25 ( 9.25-7). This is because had the opprotunity to borrow not been there, the firm would have to make do with just 2 units that it initially had and whch would have given an output of 7 units in comparison to the max benefit of 9.25 which was realized through additional financings

2(a) Billy would borrow 50 units based on the demand curve (75-(250*0.1)) which is equal to 50

2(b) As of now with 50 units of loan take, Bily needs to repay 55 units back and hence stands at a 5 unit loss. However, if we get to know the profits it generated from using the 50 units then we might be able to calculate the gains. Probably some informaion needs to be provided

Initial Amount 2 Interest Rate 0.5 Invest Output Borrow Repay Keep 1 3.75 0 0 3.75 2 7 0 0 7 3 9.75 1 1.5 8.25 4 12 2 3 9 5 13.75 3 4.5 9.25 6 15 4 6 9

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