Question

Which of the following statements is true?

		A) A market imperfection exists if the promised borrowing rate is higher than the expected borrowing rate.
		B) A market imperfection exists if the promised savings rate is higher than the promised borrowing rate.
		C) A market imperfection exists if the expected borrowing rate from the lenderʹs perspective differs from the expected borrowing rate from the borrowerʹs perspective.
		D) All of the above are market imperfect Which of the following statements is true? A) A market imperfection exists if the promised borrowing rate is higher than the expected borrowing rate. B) A market imperfection exists if the promised savings rate is higher than the promised borrowing rate. C) A market imperfection exists if the expected borrowing rate from the lenderʹs perspective differs from the expected borrowing rate from the borrowerʹs perspective. D) All of the above are market imperfect

Answer 1

It is option D.
All of the above are market imperfect

We need to understand what imperfect markets are: it is a market where buyers perspective differs from seller's perspective leading to not matching of buyers and sellers immediately. There is a friction in the market.

1. It happens when Expected return differs from required rate of return i.e promised return.
2. Savings return > Borrowing return.
It causes an arbitrage opportunity.
For example borrow at 5% and save at 7%. There is a free profit of 2%.
3. When there is a difference in perspective it causes a friction. Thus leading to imperfect market conditions.

For example: suppose you want to take a home loan for 6% per annum and you feel it is a genuine rate. But bank is ready to lend from 10% per annum. Bank feel it is genuine rate from its point of view.
What will you do in such a situation?
There is friction!!
There will be no buyer or seller in such a case.
They will come to an agreement between 6% and 10%. 6% will go up and 10% will come down to create perfect markets.