Adverse selection is a problem associated with equity and debt contracts arising from
A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.
B) the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.
C) the borrower's lack of incentive to seek a loan for highly risky investments.
D) the lender's inability to restrict the borrower from changing his behavior once given a loan.
A
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What will be an ideal response?
In the scenario above, which of the following actions will maximize the industry's economic profit?
A) Both firms comply with the agreement. B) Both firms cheat on the agreement, producing more than the agreed amount. C) One of the firms complies with the agreement while the other firm cheats, producing more than the agreed amount. D) Because the firms are colluding, the profit does not change regardless of whether the firms comply with agreement or cheat on the agreement.