Moral hazard speculation, Summaries of Economics

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MARKET FAILURE

MORAL HAZARD, SPECULATION, AND MARKET

BUBBLE

Market failure, in economics, is a situation defined by an inefficient distribution of goods and services in the free market. In market failure, the individual incentives for rational behavior do not lead to rational outcomes for the group. In other words, each individual makes the correct decision for themselves, but those prove to be the wrong decisions for the group. WHAT IS MARKET FAILURE?

It’s important to understand moral hazard because of its impact on both consumers and the economy. The core problem of moral hazard is one of excessive risk-taking. Individuals may feel that they do not need to take precautions because their insurance policies will cover any damages, even if they are still required to pay their deductible or coinsurance. Homeowners may decide to cut back on security measures because of their property and fire insurance, and car insurance holders may take less caution on the roads.

WHY UNDERSTANDING MORAL HAZARDS IS IMPORTANT?

The global financial crisis : The 2007–2008 global financial crisis was a textbook example of moral hazard in banking. Lower interest rates sent borrowers after cheap loans that lenders provided to banks that then sold them to investors. But when the Federal Reserve, or Fed, raised interest rates, the housing market crashed. Homeowners defaulted on their subprime mortgages, sending investors and banks into bankruptcy. The government’s attempt to lessen the damage caused a loss of trillions of dollars from the global economy. REAL SITUATION AND EFFECT OF MORAL HAZARD

A bubble is an economic cycle that is characterized by the rapid escalation of market value, particularly in the price of assets. This fast inflation is followed by a quick decrease in value or a contraction, which is sometimes referred to as a "crash" or a "bubble burst.“ A market bubble occurs when rising demand, for whatever reason drives prices beyond the level that might normally be expected. As more buyers join in, the value of what they are buying increases, in turn encourages more buyers, which forces the price even higher and it becomes an upward cycle. MARKET BUBBLE

The Japanese economy experienced a bubble in the 1980s after the country's banks were partially deregulated. This caused a huge surge in the prices of real estate and stock prices. The dot-com boom, also called the dot-com bubble, was a stock market bubble in the late 1990s. It was characterized by excessive speculation in Internet-related companies. During the dot-com boom, people bought technology stocks at high prices—believing they could sell them at a higher price—until confidence was lost and a large market correction occurred. EXAMPLES OF MARKET BUBBLE