4.4.2 - Market Failure In The Financial Sector

Question 1

What Are Types Of Market Failure, That Occurs In The Financial Sector?
(5 Points)

Answer 1

~ Asymmetric information.

~ Negative externalities.

~ Moral hazard.

~ Speculation and market bubbles.

~ Market rigging.

Question 2

Describe ‘Asymmetric Information’ As A Type Of Market Failure In A Financial Market
(3 Points)

Answer 2

~ Financial institutions, have more knowledge compared to customers.

~ Meaning that customers are sold products they don’t need, which are cheaper elsewhere and are riskier than the buyer realises.

~ E.g. 2008 financial crises, between financial regulators and financial markets.

Question 3

Describe ‘Negative Externalities’ As A Type Of Market Failure In A Financial Market
(3 Points)

Answer 3

~ When individuals, firms and the government have to contribute to something, that has nothing to do with them.

~ This affects demand, growth and employment in the economy.

~ E.g. Costs to taxpayers, during 2008 to bail out the banks.

Question 4

Describe ‘Moral Hazard’ As A Type Of Market Failure In A Financial Market
(3 Points)

Answer 4

~ When somebody faces the consequence, for other parties risky behaviour.

~ E.g. In 2008 banks didn’t feel the consequences, when the government had to bail them out.

~ E.g. If it happened again, the banks knew the government would just bail them out again.

Question 5

Describe ‘Speculation & Market Bubbles’ As A Type Of Market Failure In A Financial Market
(4 Points)

Answer 5

~ Speculation, leads to a market bubbles.

~ When the prices rise, meaning investors buy more of the asset, due to speculation.

~ This leads to prices being so high it creates a bubble.

~ Investors see the asset isn’t worth that much, and begin to sell for a lower price.

Question 6

What Is A Market Bubble?
(3 Points)

Answer 6

~ When asset prices rise, demand for the asset increase.

~ Increasing the price of the asset further, due to people demanding more due to speculation.

~ Until it becomes hugely overvalued and the bubble bursts.

Question 7

Describe ‘Market Rigging’ As A Type Of Market Failure In A Financial Market
(2 Points)

Answer 7

~ Where individuals or institutions, collude to fix prices or exchange information that will lead to gains for themselves.

~ E.g. LIBOR scandal of 2008.