How does the practice of banks offering low interest rates to people with good credit relate to the concept of consumer surplus and willingness to pay?

• A. It decreases consumer surplus for those with good credit, since they pay more than their willingness to pay.
• B. It has no effect on consumer surplus, because interest rates do not influence willingness to pay.
• C. It increases consumer surplus for those with good credit, as they pay less than their maximum willingness to pay for loans.
• D. It reduces willingness to pay for all consumers, regardless of credit score.

Answer: (C)

Verified step by step guidance

1. Step 1: Understand the concept of consumer surplus. Consumer surplus is the difference between what a consumer is willing to pay for a good or service and what they actually pay. It represents the net benefit or gain to the consumer from a transaction.
2. Step 2: Define willingness to pay in the context of loans. Willingness to pay is the maximum interest rate a borrower is willing to accept for a loan, reflecting the value they place on borrowing funds.
3. Step 3: Analyze how offering low interest rates to people with good credit affects their payment. Since these borrowers receive loans at interest rates lower than their maximum willingness to pay, they pay less than what they are willing to pay.
4. Step 4: Connect this to consumer surplus. Because these borrowers pay less than their willingness to pay, the difference between their willingness to pay and the actual interest rate paid increases, thereby increasing their consumer surplus.
5. Step 5: Conclude that offering low interest rates to good credit borrowers increases their consumer surplus, as they gain additional benefit from paying less than their maximum willingness to pay.