4.4.2 - market failure in the financial sector

5 types of market failure in the financial sector

asymmetric information

negative externalities

moral hazard

speculation + market bubbles

market rigging

key example of market failure in the financial sector

global financial crisis 2008

asymmetric information definition

when one party has more information than another in a transaction

asymmetric information example

FINANCIAL CRISIS: sellers knew the risks of the subprime mortgages they were giving out better than the consumer and even the financial regulators

negative externality definition in this context

negative spillover effects of economic activity on a third party outside of the price mechanism

negative externality example

FINANCIAL CRISIS: someone becoming unemployed but they weren’t involved in the mortgage issues that caused it

moral hazard definition

when an economic agent takes more risks knowing someone else will face the consequences

moral hazard example

FINANCIAL CRISIS: governments stepped in to bail out banks (bore the consequences of the banks’ risky behaviour)

concept aka ‘too big to fail’

speculation + market bubbles definition

when prices for a stock or asset rise in excess of their intrinsic value as households and firms speculate a rise in demand

speculation + market bubbles example

bitcoin fast increase in price then crash as it is overvalued

market rigging definition

distorting the price mechanism through misinformation

market rigging example

barclays providing false interest rates to influence the LIBOR