Class Notes (834,228)
Canada (508,424)
Brock University (12,083)
Economics (200)
ECON 3P03 (19)
Lecture

Explaining the Puzzles.docx

2 Pages
48 Views
Unlock Document

Department
Economics
Course
ECON 3P03
Professor
Zisimos Koustas
Semester
Fall

Description
2. Explaining the Puzzles 1.1 Transactions Costs: hinder the flow of funds to people with productive investment opportunities.  Financial intermediaries make profits by reducing transactions cost. This activity explains puzzle #3. Specifically, financial intermediaries reduce transaction costs. a) By taking advantage of economies of scale. Example: mutual funds. b) By developing expertise to lower transactions costs. Example: Commercial Banks. 1.2 Adverse selection It is a symptom of asymmetric information  It applies prior to the transaction  Potential borrowers most likely to produce an adverse outcome are the most likely to seek loans and be selected Financial intermediaries are important in addressing. This problem George Arerlof has shown how adverse selection influences financial structure through his famous “lemons problem” in the used-car market. The lemons problem States of the world Probability Price under certainty State 1 (peach) 0.5 $10K State 2 (lemon) 0.5 $5K The price of a used car under uncertainty-not knowing if the car is a peach or a lemon-is determined by the expected utility of a used car. E(u)=0.5x$10K+0.5x$5K=$7.5K (1) The problem for the functioning of the used-car market is that sellers of good used cars will not sell. Sellers of lemons have a great incentive to sell. Clearly, the used-car market will be dominated by lemons and used-car buyers will be discouraged. 1.2.1 The Lemons Problem in Securities Markets  If an investor cannot distinguish between good and bad securities, she will be willing to pay only the average of good and bad securities v
More Less

Related notes for ECON 3P03

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit