Final answer:
Financial Institutions reduce information collection costs through economies of scale and specialization, while federal government regulation changes can further lower these costs by standardizing procedures. The government's role is not in absorbing costs but in creating a conducive regulatory environment that allows FIs to operate more efficiently.
Step-by-step explanation:
Financial Institutions (FIs) solve the problem of high information collection costs by acting as intermediaries between lenders, borrowers, and financial markets. They absorb the costs associated with gathering and processing information, evaluating credit risks, and monitoring borrowers. This is because they can take advantage of economies of scale and specialization in evaluating credit risks more efficiently than individual lenders or borrowers could on their own.
When the federal government modifies bank regulations, such as making it cheaper and easier for banks to make home loans, this can further reduce information costs by standardizing lending processes and credit evaluations. As a result, banks can extend credit more freely, knowing that regulations are designed to maintain financial stability and reduce the risk of default. This regulatory change is a reflection of the functioning market system as an efficient mechanism for distributing financial capital through market-driven interest rates and credit availability.
However, this does not necessarily mean that financial institutions pass information costs to the government. Rather, government regulations can influence the cost structure within which financial institutions operate, making it more feasible for them to provide financial services at a lower cost. This interaction between government policy and financial market operations is a critical aspect of a vibrant and responsive financial system.