Chapter 4, Problem 1QFT

To determine

The Financial benefit for Medallion Financial from the restriction on the New York Taxi medallions.

Concept Introduction:

When price rises of a good, lenders are ready to provide loans to borrowers who pledge their goods as collateral. If the borrowers fail to repay their debt, the recovery is made by selling those goods. As the price continues to increase, there is a capital gain for the lenders. As a result, they see very little downside risk of giving a loan. When the price suddenly falls, they could suffer a huge loss.

Explanation of Solution

Lenders benefit when there is a restriction on the number of New York City taxis. Due to restriction on numbers of taxi, they could provide large loans to finance the purchase of taxis and hence earn lot of profit. Many financial companies provided loans to the people to buy taxis. If the borrowers fail to repay the loan the companies take possession of the taxis. As the prices of taxis kept increasing steadily, it provided lenders capital gain in case of default.

If there is restriction on the number of taxis, the demand for taxi Medallions increases. As a result loans offered by financial companies increase. The interest on large number of loans provides them increased profit.