Market failures

Question 1

What were the economic conditions like pre crisis?

Answer 1

There had been steady growth, full employment and low inflation which led to a state of over confidence

Question 2

Why was there so little financial regulations?

Answer 2

Many people believed in the invisible hand of the market correcting prices so there was no need for regulation

Question 3

What did Hyman Minsky argue?

Answer 3

That financial markets are inherently unstable and in particular long periods of prosperity sow the seeds for future crises

Question 4

How did speculators try to cover debts?

Answer 4

They invested in hope that their invested money would cover their debt in the future.

Question 5

Minksy movement

Answer 5

A greater emphasis on financial regulation and also macro prudential policies to counter bubbles

Question 6

How did moral hazard play a role in the financial crisis?

Answer 6

Banks knew that the government would bail them out if people defaulted on their loans so they gave out too many risky sub prime mortgages, knowing the government would pay the price

Question 7

Market efficiency theory

Answer 7

Market efficiency theory says that stocks always trade at their fair value on the stock exchange so it is impossible to outperform the market. Therefore the only way to obtain higher returns is by investing in riskier stocks

Question 8

How did banks exploit asymmetric information in the crisis?

Answer 8

They were selling securities of risky mortgages to third party investors as supposedly high quality stocks despite knowing they weren’t high quality

Question 9

Bounded rationality

Answer 9

The idea that all decision makers have limited rationality. The cognitive limitations of the mind and the time available to make decision both impact rationality.

Question 10

Causes of financial crisis

Answer 10

• market efficiency theory
• deregulation of financial markets
• instability of markets
• banks exploiting asymmetric information
• no credit rating agencies and so banks were complacent
• moral hazard led to over confident financial market
• bankers’ bounded rationality that enabled moral hazard
• lack of government intervention

Question 11

Pareto efficient

Answer 11

If it is not possible to make somebody better off without making somebody else worse off

Question 12

Competitive markets assumptions

Answer 12

• price taking firms
• no interference with markets
• perfect information
• complete markets
• tastes are given

Question 13

Possible reasons for market failure

Answer 13

• monopoly
• barriers to trade
• externalities
• imperfect information
• rationality and consistency or agents

Question 14

Ways of government intervention

Answer 14

Monetary policy, fiscal policy, structural adjustment

Question 15

How can we determine if a policy has had the desired effect?

Answer 15

•stats techniques to isolate and evaluate the factors
•comparative statics between similar countries (terrible twins)
•randomised control trials (not always possible to run)
•observational studies
•

Question 16

What did Alexander Hamilton do?

Answer 16

• he established the banking system, his monetary policy provided a higher burst of credit to supply construction projects
• he restructured debts after the war of independence, this restored USA’s credit rating
• he rejected a more free market and encouraged an active government in an attempt to improve technology and underpin the industrial take off

Question 17

Why is the manufacturing sector declining in the uk?

Answer 17

Because as people get richer they tend to buy more services and less goods

Question 18

What can be done to increase manufacturing in the UK?

Answer 18

• do nothing, this is the Laissez faire approach where it is believed markets are better without state intervention
• horizontal measures
• industrial strategy

Question 19

Horizontal measures

Answer 19

Involves encouraging innovation through spending on basic science and R&D tax credits; encouraging skill development through government subsidies for higher and further education and vocational training

Question 20

Industrial strategy

Answer 20

Sector policies to support key industries with funding for collaborative research. This strategy draws in the experience of other countries such as korea, Finland and Singapore in trying to develop a new industrial strategy

Question 21

Federalism

Answer 21

The division of powers and functions between national government and state governments

Question 22

Centralisation

Answer 22

The concentration of control of an activity or organisation under a single authority

Question 23

Advantages of centralisation

Answer 23

• They are aware of externalities and can provide the amount of goods and services that maximises welfare
• there isn’t over representation from certain states
• a clear chain of command with a focused vision
• quicker decisions can be made

Question 24

Disadvantages of centralisation

Answer 24

• it gives very few people a lot of power which could be dangerous
• it doesn’t allow for specific needs in certain states

Question 25

What does the house represent in USA?

Answer 25

The house represents the will of the people

Question 26

What does the senate represent in the USA?

Answer 26

The senate represents the state’s interests

Question 27

Example of goods provided by government

Answer 27

National Defence

Question 28

Example of goods provided by state

Answer 28

Parks and recreation