Part 1Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial system. When Gustavo applied for a mortgage, he found that banks usually required collateral for up to 300% of the amount of the loan. Part 2Why might banks require that much collateral in a financial system like Gustavo's country? A. An inefficient legal system implies weak property rights but also high property values, making collateral more highly valued and hence more desirable. B. An inefficient legal system implies strong property rights, and under such a strong system, collateral is more highly valued and hence more desirable. C. An inefficient legal system implies weak property rights, and collateral helps banks recoup some of their loan if the borrower defaults. D. An inefficient legal system implies strong property rights, and collateral helps banks recoup some of their loan if the borrower defaults. Part 3As a result, when compared to other countries, we would expect Gustavo's nation to have: A. more investment and faster economic growth. B. less investment and slower economic growth. C. more investment and slower economic growth. D. less investment and faster economic growth.

Question

Part 1Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial system. When Gustavo applied for a​ mortgage, he found that banks usually required collateral for up to​ 300% of the amount of the loan. Part 2Why might banks require that much collateral in a financial system like​ Gustavo's country? A. An inefficient legal system implies weak property rights but also high property​ values, making collateral more highly valued and hence more desirable. B. An inefficient legal system implies strong property​ rights, and under such a strong​ system, collateral is more highly valued and hence more desirable. C. An inefficient legal system implies weak property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. D. An inefficient legal system implies strong property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. Part 3As a​ result, when compared to other​ countries, we would expect​ Gustavo's nation to​ have: A. more investment and faster economic growth. B. less investment and slower economic growth. C. more investment and slower economic growth. D. less investment and faster economic growth.

BlackTom AI · Accepted Answer

We start by restating the question and listing the answer choices for clarity.
Part 2 question: Why might banks require up to 300% collateral in Gustavo's country?
Options:
A. An inefficient legal system implies weak property rights but also high property values, making collateral more highly valued and hence more desirable.
B. An inefficient legal system implies strong property rights, and under such a strong system, collateral is more highly valued and hence more desirable.
C. An inefficient legal system implies weak property rights, and collateral helps banks recoup some of their loan if the borrower defaults.
D. An inefficient legal system implies strong property rights, and collateral helps banks recoup some of their loan if the borrower defaults.
Part 3 question: As a result, when compared to other countries, we would expect Gustavo's nation to have:
A. more investment and faster economic growth.
B. less investment and slower economic growth.
C. more investment and slower economic growth.
D. less investment and faster economic growth.
Now, analyze each option in turn.
Part 2, Option A: This says the system is inefficient and yet property values are high, making collateral highly valuable. The mismatch here is that if the legal system is inefficient and property rights are weak, property values would not reliably be high or secure for collateral; the fundamental risk is credit risk and enforcement risk. Simply claiming high property values as a stabilizing factor ignores the weak enforcement of claims and the potential for legal disputes to erode collateral value.
Part 2, Option B: This states that an inefficient system implies strong property rights. That is inconsistent with the typical interpretation of an inefficient legal system, which would usually entail weak rights and weak enforcement. Therefore this option misstates the core relationship and is unlikely to be correct.
Part 2, Option C: This asserts that weak property rights exist and collateral helps banks recoup some of their loan if the borrower defaults. This aligns with standard financial reasoning: in environments with weak property rights, collateral provides a fallback mechanism to reduce losses when borrowers default, kicking in enforcement risk that otherwise wouldn't be present. It correctly ties high collateral requirements to the need to protect lenders against legal and repayment risk.
Part 2, Option D: This claims that strong property rights plus collateral protection is the mechanism. Since the premise begins with an inefficient legal system, the claim of strong property rights is incompatible with the premise, making this option implausible.
Part 3, Option A: More investment and faster economic growth would be expected in a country with strong, reliable institutions and secure property rights, not in a country with weak rights and high collateral requirements. Thus this option contradicts the typical effect of weak institutions on investment behavior.
Part 3, Option B: Less investment and slower economic growth match the intuition that weak property rights deter investment, due to greater risk and uncertainty in returns, leading to slower overall growth. This is a coherent outcome given an inefficient legal/financial system.
Part 3, Option C: More investment but slower growth is inconsistent with the logic that high risk and weak rights depress both investment levels and growth prospects; it would be unusual for investment to rise if rights are weak and enforcement unreliable.
Part 3, Option D: Less investment and faster growth is internally contradictory in typical macroeconomic reasoning, since reduced investment generally correlates with slower, not faster, growth when institutions are weak.
Bringing the insights together: for Part 2, the correct conceptual link is that weak property rights necessitate collateral as a tool for banks to mitigate default risk when enforcement is imperfect; hence the statement in Option C accurately captures the dynamic. For Part 3, the most reasonable expectation in comparison to countries with stronger institutions is that Gustavo’s nation would experience less investment and slower economic growth, aligning with Option B.
In summary, the reasoning across options hinges on correctly identifying how an inefficient legal system with weak property rights creates higher risk for lenders and consequently a greater role for collateral, and how this environment typically dampens investment and growth relative to better-institutional contexts. The analysis of each choice above highlights the key logical gaps in the incorrect options and the coherence of the correct ones.

Quiz:Quiz 2

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