Exercise 13.3

No Excessive Punishment

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Problem

In Section 13.3.3 we studied an environment in which creditors seize \(k\) units of goods from delinquent debtors. This threat could be viewed as excessive punishment in some states, because it implies that creditors will take away \(k\) units of goods even if the size of the defaulted debt is smaller than \(k\). A more compelling assumption is that the punishment takes the form \(\min\{k,d(\epsilon)\}\), where \(k\in (0,\epsilon^H)\) and \(d(\epsilon)\) denotes the debt obligation in state \(\epsilon\). Show that the analysis of Section 13.3.3 goes through under this assumption.

Answer

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