PROBLEM A:

Because credit card companies and banks must charge the same interest rate on credit cards to all borrowers, there is an adverse selection problem with credit cards. How does a credit card company or firm know whether a person will be a high-quality borrower (i.e., one who pays the debts) or a lower-quality borrower (i.e., one who does not pay debts)?

Describe

a. how the restrictions of a single rate leads to an adverse selection problem, and

b. at least two potential means that credit card companies can use to try to lessen this problem.

PROBLEM B:

Suppose three firms face the same total market demand for their product. This demand is

P           Q
$80   20,000
70     25,000
60     30,000
50     35,000

Suppose further that all three firms are selling their product for $60 and each has about one third of the total market. One of the firms, in an attempt to gain market share at the expense of the others, drops the price to $50. The other two quickly follow suit.

a. What impact would this move have on the profits of all three firms? Explain your reasoning.

b. Would these firms have been better off in terms of profit if they all had raised the price to $70? Explain.