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In the model of banks as providers of liquidity insurance, I examined four cases. Autarky, a market economy with borrowing and lending, the Pareto optimum and how banks can achieve the Pareto optimum.

a) Why is the equilibrium in the market economy preferred to that under autarky?

b) Why is the market economy NOT a Pareto optimum?

c) What feature of the model permitted the economy with banks to achieve the Pareto optimum.

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