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 strong property rights, and under such a strong system, collateral is more highly valued and hence more desirable. B. An inefficient legal system implies strong property rights, and collateral helps banks recoup some of their loan if the borrower defaults. C. An inefficient legal system implies weak property rights, and collateral helps banks recoup some of their loan if the borrower defaults. Your answer is correct.D. An inefficient legal system implies weak property rights but also high property values, making collateral more highly valued and hence more desirable. 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 faster economic growth. C. less investment and slower economic growth. D. more investment and slower 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 strong property​ rights, and under such a strong​ system, collateral is more highly valued and hence more desirable. B. An inefficient legal system implies strong property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. C. An inefficient legal system implies weak property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. Your answer is correct.D. An inefficient legal system implies weak property rights but also high property​ values, making collateral more highly valued and hence more desirable. 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 faster economic growth. C. less investment and slower economic growth. D. more investment and slower economic growth.

BlackTom AI · Accepted Answer

First, consider the scenario: Gustavo operates in a country with an inefficient legal and financial system, and banks require collateral up to 300% of the loan amount. This setup points toward how lenders manage risk when property rights are uncertain or weak.
Option A: It claims that an inefficient legal system implies strong property rights, and that collateral is more valuable under such a system. This is inconsistent with the premise. An inefficient system typically weakens property rights, not strengthens them, so this option misstates the core relationship and misattributes why collateral would be desired.
Option B: It states that an inefficient legal system implies strong property rights, and that collateral helps banks recoup some of their loan if the borrower defaults. Again, the premise describes inefficiency leading to weak property rights, not strong, so this option contradicts the setup and would undermine the rationale for heavy collateral.
Option C: It asserts that an inefficient legal system implies weak property rights, and collateral helps banks recoup some of their loan if the borrower defaults. This aligns with standard risk-management reasoning: when property rights are weak, courts may be slow or unreliable in enforcing contracts, so lenders demand collateral to protect themselves and increase recoveries in case of default. The high collateral requirement encapsulates this precaution.
Option D: It claims that an inefficient legal system implies weak property rights but also high property values, making collateral more desirable. While weak property rights fit the premise, the claim of automatically high property values is not a given consequence and can be inconsistent across economies; the primary driver for collateral demand is enforcement risk, not assumed high asset values, so this option introduces an unfounded assumption about property values.
In summary, Option C directly ties the inefficiency of the legal system to weak property rights and explains why collateral serves to recoup loans in default, whereas the other options either misstate the basic relationship between inefficiency and property rights or add unsupported claims about values or mechanisms. This alignment makes Option C the coherent choice given the described context.

Homework:Chapter 8 Homework

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