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Bank Depositors (GMAT Prep)

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Bank Depositors (GMAT Prep)

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Bank depositors in the United States are all financially protected against bank failure because the government insures all individuals' bank deposits. An economist argues that this insurance is partly responsible for the high rate of bank failures, since it removes from depositors any financial incentive to find out whether the bank that holds their money is secure against failure. If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

The economist's argument makes which of the following assumptions?

(A) Bank failures are caused when big borrowers default on loan repayments.
(B) A significant proportion of depositors maintain accounts at several different banks.
(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank.
(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures.
(E) Potential depositors are able to determine which banks are secure against failure.

OA E

Can you explain why B is incorrect and E is right.

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mals24 wrote:
Bank depositors in the United States are all financially protected against bank failure because the government insures all individuals' bank deposits. An economist argues that this insurance is partly responsible for the high rate of bank failures, since it removes from depositors any financial incentive to find out whether the bank that holds their money is secure against failure. If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

The economist's argument makes which of the following assumptions?

(A) Bank failures are caused when big borrowers default on loan repayments.
(B) A significant proportion of depositors maintain accounts at several different banks.
(C) The more a depositor has to deposit, the more careful he or she tends to be in selecting a bank.
(D) The difference in the interest rates paid to depositors by different banks is not a significant factor in bank failures.
(E) Potential depositors are able to determine which banks are secure against failure.
I received a PM requesting that I respond.

Premise:
Insurance removes from depositors any financial incentive to find out whether the bank that holds their money is secure against failure.
Conclusion:
The insurance is partly responsible for the high rate of bank failures.

To determine the assumption, apply the NEGATION TEST.
When the correct answer is negated, the conclusion will be invalidated.

E, negated:
Potential depositors are not able to determine which banks are secure against failure.
Here, it is IRRELEVANT that insurance removes any financial incentive to find out whether a bank is secure, since -- even if depositors HAD incentive -- they would not be ABLE to determine which banks are secure.
Implication:
There is no link between the lack of financial incentive brought about by the insurance and the high rate of bank failures, invalidating the conclusion that the insurance is party to blame for the high rate of bank failures.

The correct answer is E.

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You can weaken an argument as follows:

1)Cause occured but the effect did not occur
2)Cause did not occur but effect occurred.
3)There was an alternate cause for the stated effect
4) Stated cause and stated effect relationship is reversed.

stated cause=>stated effect in the argument becomes
stated effect=>stated cause(this weakens it)

5) There was a problem or bias in the data under consideration used to make the argument


B

When the government did not insure deposits, frequent bank failures occurred as a result of depositors' fears of losing money in bank failures

This would fall under 2) which keads us to 3) also.



Hope this helps!

Good luck.

Regards,
CR

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Apply the rule of negation here.

Incase the potential depositers are not able to determine than the above statement does not hold good. So the author may have assumed this.

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Hey jyoti can you expain your point further by writing the conclusion as well I seem to have some difficulty in breaking the problem.

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conclusion: If depositors were more selective, then banks would need to be secure in order to compete for depositors' money.

Key point - If depositors were more selective


Assumption - there is a way for the depositors to be selective - i.e. know which banks are insured against failure.

imo E

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Thanks guys for the explanations Smile

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Continuation of the above question

II.Which of the following, if true, most seriously weakens the economist's argument?
(A) Before the government started to insure depositors against bank failure, there was a lower rate of bank failure than there is now.
(B) When the government did not insure deposits, frequent bank failures occurred as a result of depositors' fears of losing money in bank failures.
(C) Surveys show that a significant proportion of depositors are aware that their deposits are insured by the government.
(D) There is an upper limit on the amount of an individual's deposit that the government will insure, but very few individuals' deposits exceed this limit.
(E) The security of a bank against failure depends on the percentage of its assets that are loaned out and also on how much risk its loans involve.
OA: B

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Re opening the thread .

For the assumption question .Why d is not the answer ?

If its a causal relationship type question( X causes Y ) then D shld work fine .As It removes all the other possibilities & assumes that only X caused Y .Moreover for the very next question ( the weaken one ) as the correct answer is B .So this also proves that the ECONOMISTS' CONCLUSION is --> "this insurance is partly responsible for the high rate bank failures." not "If depositors were more selective, then banks would need to be secure in order to compete for depositor's money."
& if this is the economists conclusion ( 'economists argument' is in the question in both the questions ) then D shld suffice .

Please help ....

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I know this is an old thread but can someone please clarify the first question (assumption one) for me.

Conclusion - insurance is partly responsible for the high rate of bank failures (Isn't this the conclusion? Someone has mentioned the conclusion to be different previously in this thread)
Premise - depositors insured against bank failures,depositor not concerned abt finding risk free bank, no competition

I chose D on the basis that it does away with an alternate cause. Should the alternate cause be also mentioned in the passage?

I did not choose E because for E to be an assumption, the conclusion would have to be something like "The high rate of bank failures will decrease if depositors are more careful in selecting banks". The assumption in option E then makes sense.

Also, if you negate E, it says "Potential depositors are not able to determine which banks are secure against failure". This clearly strengthens the argument instead of breaking it. Bank failures rates are increasing as depositors are not able to differentiate between risk free and non risk free banks, and they deposit in banks which might fail in the future thereby increasing the failure rates.

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@vishal

Hi Vishal, even i have the exactly same question for Q-1....i guess most of the people read Power Score CR Bible for GMAT, in assumption chapter, there are two techniques

1) supporter
2) defender

if i follow the second technique then Op D seems to me perfect...even i check word to word that if there is any flaw, but haven't find any???

Any expert please clear...

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vishalchaudhury wrote:
I know this is an old thread but can someone please clarify the first question (assumption one) for me.

Conclusion - insurance is partly responsible for the high rate of bank failures (Isn't this the conclusion? Someone has mentioned the conclusion to be different previously in this thread)
Premise - depositors insured against bank failures,depositor not concerned abt finding risk free bank, no competition

I chose D on the basis that it does away with an alternate cause. Should the alternate cause be also mentioned in the passage?

I did not choose E because for E to be an assumption, the conclusion would have to be something like "The high rate of bank failures will decrease if depositors are more careful in selecting banks". The assumption in option E then makes sense.

Also, if you negate E, it says "Potential depositors are not able to determine which banks are secure against failure". This clearly strengthens the argument instead of breaking it. Bank failures rates are increasing as depositors are not able to differentiate between risk free and non risk free banks, and they deposit in banks which might fail in the future thereby increasing the failure rates.
the correct modeling of the argument is

depositors are insured -> no incentive for the depositors to shop around for the "safer" banks -> no incentive for the banks to become "safer" -> banks fail -> insurance is partly responsible for failure

E is definitely a necessary assumption, and can be reached by negation as well - if depositors are not able to determine which banks are "safe", then they won't be able to effectively "shop" for the safer banks, - breaking the chain in the second link as the banks won't have any incentive to become safer even if insurance were taken off the table. The reverse of E weakens the argument's logic, so E is indeed as assumption the author must make in order to make his point.

For the same negation technique to work with D, the conclusion needs to be stronger and more clear cut in assigning the blame ONLY or MAINLY to the insurance. If the argument had concluded that insurance IS the reason for bank failures, then D would weaken this conclusion as an alternative explanation for bank failures. But the conclusion that insurance is "partly responsible" for failures is not really weakened by the introduction of another factor in bank failures such as interest rates - the two can coexist as partial factors.

The key to correctly handling CR questions is to determine to yourself what the right answer should do, BEFORE looking at the answer choices. Read the argument, construct the "chain of reasoning" above, then ask yourself "what must the author assume for this to be true?". One thing that pops us is "the author's argument talks about giving the depositors the incentive to choose the safer banks, but doesn't say that they are able to make intelligent and informed decisions, given the incentive to do so - he's assuming this ability as a given". Then go and look for an answer choice that says that, and do not let yourself be swayed by trap answer choices that also "seem" right.

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Thank you very much vishalchaudhury for raising this question

and thank you so very much Geva@EconomistGMAT for answering this question so beautifully. I was stuck with this same question from past 2 days and Geva's answer finally came to rescue.

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