Question

Q4a (10 points) a) Name and explain the two roles banks play in the economy discussed in class. + Drag and drop your files or click to browse.. Q4b (10 points) Use the following information to answer parts 4b, 4c, and 4d: Consider an economy with a large number of restaurants. The restauranteur lacks the funds to start the restaurant. There is an equal number of investors who have the funds but no desire run a restaurant, say 2 trillion investors. Each investor has 10 goods to invest. Each restauranteur requires 20 goods. Assume that 20% of the restaurants fail and return zero goods to the investor and the remaining 80% return 40 goods. The monitoring cost is 10 good per failed project. b) Compute the expected total return for each investor + Drag and drop your files or click to browse...

Answer 1

4)a) Two roles played by Banks in the economy are as follows:-

• Creation Of Credit: Banks play a major role in the procerss of credit creation. They accept money from people, Business concerns, institutions, Enterprieuners, proprietors etc. through the process of deposition and lend that money to similar people maybe to investors, common people etc. at a certain interest rate. By this process they create credit in the economy and keep the flow of money intact i.e. they are responsible for keeping the money in flow. They are able to create credit because they know deposition and withdrawal can't happen in the same day by same people. They use this interval for providing loans and other lending activities.

• Transactional Agent and Treasury of a Nation: Banks are the agents who act on behalf of its clients in maintenance of all the client's transactions. They also act as a security and treasurer of wealth of its clients (Let it be people, Business concerns or the Nation). They keep contingencies, provide offers, loans for overall economic stability of a nation. By acting as a transactional agent, it also keeps a record of all money circulating within the economy which is helpful in the calculation of tax, interests and calculating economic indicators like Per Capita Income. Keeping an account also helps them track frauds and circulation of any unaccountable money.

4)b)

Number of Restaurants = Number of investors = 2 trillion (Given)

Number of goods each investor can invest = 10 (Given)

So, Total Investment = 10*2 trillion = 20 trillion goods.

Each Restaurant reqires = 20 goods.

Now, 20% of 2 trillion restaurants fail = 0.20* 2 trillion= 400 billion resataurants.

Monitoring cost for each failed project = 10 goods

Therefore Total Monitoring Cost= 10 goods*400 billion restaurants= 4 trillion goods

80% of Total restaurants= 0.80*2 trillion= 1.6 trillion restaurants return 40 goods each = 1.6 trillion*40= 64 trillion goods

Total Expected Return = Actual Goods Returned - Monitoring cost per failed project

= 64 trillion goods - 4 trillion goods = 60 trillion goods

Total Expected return for each investor = Total Expected Return/ Number of Investors

= 60 trillion goods/ 2 trillion investors = 30 goods each.(Answer)

4)c) If there are competitive banks that operate without any costs, then the investors dont need to incur the 4 trillion goods monitoring cost which is the principal - agent cost incurred by the investors. In that scenario,

Total Expected return For each investor = 64 trillion goods / 2 trillion investors = 32 goods each (Answer)

4)d)

According to the outcomes of Q 4)b) and Q 4)c), it is clear that it is always better for the investors to invest where there are Competitive Banks that operate without any costs. Furthermore loss on return on investment was expected as the requirement was of 20 goods per restaurant i.e. total 40 trillion goods were to be invested whereas only 20 trillion goods were invested due to lack of desire of investment towards restaurant s by investors. As a result optimium return was not achieved by utilisation of non-optimium investment due to lack of functionality of restaurants.