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Explain the following simple algebra of moral hazard. Suppose a real estate deal, which requires 100 million as investment today will yield 120 million with probability of 10 percent and will lose 20 million with probability of 90 percent. Suppose that the interest rate is 5 percent per annum.
(a) Without government intervention, would anyone invest in this deal?
(b) Suppose that now the deal is backed by full government guarantee. What will be the outcome? Does your answer depend on the attitude of the investor toward risk?
(c) Suppose that now government guarantying only 80 percent of the initial investment. What will be the outcome? Does your answer depend on the attitude of the investor toward risk?
Equilibrium Price
The price point at which the supply of goods aligns perfectly with the demand for those goods.
Supply
The total amount of a specific good or service that is available to consumers, often influenced by price, production costs, and market demand.
Bacon Cheeseburgers
A hamburger topped with bacon and cheese, serving as a popular American fast food dish.
Price Decreases
Reductions in the cost of goods or services, often leading to increased demand.
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