Chapter 8 Mishkin Notes Essay

1353 Words Nov 9th, 2012 6 Pages
An Economic Analysis of
Financial Structure
Why do Financial Institutions Exist?
(Why is Indirect Finance so Important?)

Chapter 8

Chapter Preview
W e take a closer look at why financial institutions exist and how they promote economic efficiency.
Topics include:
• A Few Basic Facts About Financial Structure
• Transaction Costs
• Asymmetric Information: Adverse Selection and
Moral Hazard

Chapter Preview (cont.)
• The Lemons Problem: How Adverse Selection
Influences Financial Structure
• How Moral Hazard Affects the Choice Between
Debt and Equity Contracts
• How Moral Hazard Influences Financial
Structure in Debt Markets


Basic Facts About Financial Structure
Throughout the World
• The chart on the next
…show more content…
Occurs when one party has an incentive to behave differently once an agreement is made between parties


After transaction occurs


Hazard that borrower has incentives to engage in undesirable (immoral) activities making it more likely that won't pay loan back


Health Insurance
• Symmetric Information: Suppose, if you get sick, drugs cost $10,000/year
• Everyone has a 1/10 chance of getting sick
• Solution - Insurance will be offered at $1,000 per year Health Insurance – Symmetric Information continued • Suppose 10% of the population (2 out of 20) is sickly and has a 50%(1/2) chance of getting sick
- independent.
• Other 90% (18 people) only has 1/18 chance of getting sick.

• This information in known to everyone.
• How do you price the insurance?

Health Insurance – Symmetric Information continued • Sickly types pay?
• Healthy types pay?


Health Insurance - Asymmetric Information
Adverse Selection
• Same as previous example, but one’s type
(sick or healthy) is private information.

Suppose insurance company

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