Market failure in the financial sector 4.4.2

Question 1

types of market failure

Answer 1

asymmetric information
externalities
moral hazard 
speculation and market bubbles
market rigging

Question 2

asymmetric information

Answer 2

financial institutions have more info than their customers (financial crisis partially caused by banks selling packages of subprime mortgages as prime, which consumers wouldn’t have bought if they knew the risk)
they have little incentive to help regulators understand their business so regulators may end up allowing them to partake in harmful activities

Question 3

externalities

Answer 3

costs to a third party eg tax payers bailing out banks had long term costs to the economy

Question 4

moral hazard

Answer 4

individuals make decisions in their own best interest 1. taking risks to increase salaries as it would be the companies problem if it fails, the worst for them is being fired (financial crisis they sold mortgages to people who couldn’t pay back for higher salaries
financial institutions may take risks because they know the central bank won’t let them fail

Question 5

speculation & market bubbles

Answer 5

market bubbles are where prices rise a lot then fall
investors see the price of an asset is rising so they buy it to profit in the future, the price keeps rising until a point where investors decide price will fall. they sell causing others to sell (herding behaviour) which happened in the housing marketand when there’s an increase in interest rates etc the bubble bursts

Question 6

market rigging

Answer 6

colluding to fix prices or exchange info for gains for themselves (insider trading when they know something about what’ll happen in thee future and buy or sell shares to make profit)
affecting the price of a commodity/currency/asset- large trades in a currency will shift its value