Question from Past Microeconomics Qualifying Exam[]

Fall 2000 - Section I, Question two, George Mason University

True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.

Laws permitting bankruptcy make borrowers better off.


Uncertain. While strictly speaking, borrowers are better off because it can prevent the bank from collecting more than they otherwise would, banks are also less likely to lend. Bankruptcy laws lower a bank's capacity to recover from defaults, making them less likely to loan to high-risk/high-payoff clients and more likely to loan to low risk/low payoff clients. Particularly favorable bankruptcy laws can result in many potential borrowers being denied funds, even if they are likely to pay back the debt.

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