Discrimination in Lending.

Imagine a community where the majority discriminates against a minority population. The minority population is 15% of the total. Now consider a simple model of lending with four different sets of assumptions. Two possible assumptions are that the loan market does or does not clear. Each of these may be paired with the assumption that prejudice is weak or strong.

Lenders with weak prejudice decline to lend to a qualified minority borrower only if forced to choose between the minority and an equally qualified majority borrower. Lenders with strong prejudice will never lend to a minority borrower. In the case of strong prejudice, assume that when it exists it applies to 80% of lenders, but that the remaining 20% of lenders have only weak prejudice. The shortage of loans when the market does not clear is 25%.

For each of the four possible assumption pairs, (market clears or not; prejudice strong or weak) indicate the percentage of qualified minorities that receives a loan. Does the percentage depend on whether the loan market clears? Does it depend on which assumption we make regarding prejudice? Explain. Why might the loan market fail to clear? If the market doesn’t clear, what fraction of qualified majority applicants gets denied? Explain.