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4.4.2 Market Failure in the Financial Sector (Edexcel A-Level Economics Teaching PowerPoint)


Last updated 1 Nov 2023

This Edexcel teaching powerpoint covers Market Failure in the Financial Sector

Financial markets can experience market failure for several reasons, including:

  • Moral hazard: When investors are protected from the consequences of their actions, they may engage in riskier behavior than they would otherwise. This can lead to a misallocation of resources and a build-up of risk in the financial system.
  • Information asymmetry: If some market participants have better information than others, this can lead to mispricing of assets and inefficiencies in the market.
  • Systemic risk: If there is a widespread failure of financial institutions, this can lead to a domino effect and a widespread economic collapse. This is known as systemic risk and can be difficult to predict and manage.
  • Lack of regulation: Inadequate or ineffective regulation of financial markets can lead to excessive risk-taking, fraud, and other forms of misconduct.

Speculative bubbles are a classic example of market failure in the financial sector. In a speculative bubble, asset prices become detached from their fundamental value due to over-exuberance and over-optimism on the part of market participants. This can lead to a rapid increase in prices, followed by a crash when the bubble bursts. Examples of speculative bubbles include the dot-com bubble of the late 1990s, the housing bubble of the 2000s, and the tulip mania of the 1600s. Speculative bubbles can cause significant economic harm when they burst, as investors lose money and confidence in the market declines.

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