Evaluating a Lending Model's Predictive Failure
A commercial bank develops a new lending model based solely on an applicant's wealth and the projected profitability of their proposed investment. The model is designed to simplify the loan approval process. In its first year, the model correctly predicts 95% of loan outcomes (i.e., successful repayment or default). However, the model denies a loan to an applicant with very little personal wealth, who then goes on to secure funding elsewhere and builds an extremely successful company. A critic argues that this single, high-profile failure proves the bank's model is fundamentally useless. Based on the nature and purpose of economic models, evaluate the critic's claim.
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Social Science
Empirical Science
Science
Economy
CORE Econ
Economics
Ch.2 User-centered design process - User Experience Design - Winter 23 @ UI Design in UI @ University of Michigan - Ann Arbor
UI Design in UI @ University of Michigan - Ann Arbor
User Experience Design - Winter 23 @ UI Design in UI @ University of Michigan - Ann Arbor
UI @ University of Michigan - Ann Arbor
User Experience Design @ UI Design in UI @ University of Michigan - Ann Arbor
University of Michigan - Ann Arbor
Introduction to Microeconomics Course
The Economy 2.0 Microeconomics @ CORE Econ
Ch.9 Lenders and borrowers and differences in wealth - The Economy 2.0 Microeconomics @ CORE Econ
Evaluation in Bloom's Taxonomy
Cognitive Psychology
Psychology
Related
An economist observes that in a small, close-knit community, some individuals with no collateral and low income are able to secure small loans from local lenders, while outsiders with identical financial profiles are denied. Standard economic models of lending, which focus on an individual's wealth and project viability, do not fully predict this outcome. Which of the following statements best analyzes this discrepancy by considering the nature of economic models?
Evaluating the Utility of Simplified Economic Models
An economic model designed to explain lending behavior is considered flawed and should be discarded if it cannot accurately predict the outcome of every single loan application in the real world.
The Purpose of Simplification in Economic Models
Evaluating a Lending Model's Predictive Failure
Standard economic models of borrowing and lending simplify reality to focus on key principles like wealth and project viability. Match each real-world factor below with the most likely reason it is often omitted from these basic models.
Extending Economic Models of Lending
A financial analyst develops a new model to predict loan defaults. The model is praised for its simplicity and ability to clearly illustrate the relationship between a borrower's income and their likelihood of repayment. However, it is criticized for failing to account for dozens of other variables, such as local unemployment rates or unexpected health crises, thus failing to predict every default perfectly. From the perspective of economic modeling, what is the most accurate assessment of this situation?
The Trade-Off in Economic Modeling
Analyzing a Model's Predictive Failure
The Purpose of Simplification in Economic Models