Effects of credit limit on efficiency and welfare in a simple general equilibrium model

Abstract

We consider a simple general equilibrium model with two agents under the presence of financial market imperfections: agents can borrow to realize their productive project up to the level of debt whose repayment reaches a fraction of the project's value (so-called credit limit). After characterizing the whole set of equilibria, we investigate the connection between credit limit, (individual and social) welfare, and efficiency. We also compute the optimal credit limit which maximizes the social welfare function