Market failure in the financial sector Flashcards
What are all the forms of market failure in the financial sector
- Asymmetric information
- Externalities
- Moral Hazard
- Speculation and market bubbles
- Market rigging
- Adverse selection
How does asymmetric information result in market failure
Financial institutions have more knowledge compared to customers, they will abuse this to sell customers products like insurance packages that are risky or simply not needed.
How do externalities result in market failure
Negative externalities created by the financial market like costs created by crisis that fall onto government, firms and consumers
How does Moral Hazard in workers result in market failure
Workers taking excessive risks to improve their salary and problems won’t fall on them but the company
How does Moral Hazard in financial institutions result in market failure
Financial institutions may take excessive risks as they know the government and central bank won’t let them fail as this would have huge negative impact on economy
How does speculation and market bubbles result in market failure
All financial market trading is speculative so when price is rising investors will purchase it which creates a market bubble as price continues to rise excessively, investors then speculate price to fall when it reaches a level which causes them to panic sell and crash the market.
What is a market bubble
Investors may see price of an asset rising so buy that asset, herding behaviour in this causes price to rise very high
How did the financial market cause market bubbles in the housing market
Lending too much in mortgages drove up demand for housing, but when a rise in interest rates causes a fall in demand for houses and negative wealth effect and fall in AD so banks are left with loans that won’t be repaid
How does Market Rigging result in market failure
Institutions collude to fix prices which leads to gains for themselves to the detriment of others in the market, usually customers
What is insider trading
Individual or institution has knowledge of future happenings that isn’t common knowledge so can use this to profit unfairly.
2008 LIBOR scandal
Financial institutions were accused of fixing the London Interbank Lending Rate, which is an extremely important rate
How does adverse selection cause market failure
Selling to unworthy buyers so financial institutions giving loans to people whether know can’t repay them
