Market Failure In The Financial Sector – AS/A LEVELS/IB/IAL

Market Failure In The Financial Sector – AS/A LEVELS/IB/IAL

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

Market Failure in the Financial Sector – situations where there is a loss of economic output because Financial Markets are unable to operate efficiently

Types of Market Failure in the Financial Sector

1. Moral Hazard

  • Moral Hazard – where one party engages in a risky act and intentionally dismisses behaving in good faith as they know that another party will bear the consequences of their actions
  • Some bankers engage in trading highly risky securities to enhance their bonuses as they know the government will rescue them and cover the cost of the consequences

2. Asymmetric Information

  • Occurs when there is a mismatch of information where one party involved knows more information than the other
  • There are two types of Asymmetric Information which are: Moral Hazard and Adverse Selection

3. Externalities

  • Failure in Financial Markets leads to higher unemployment rates, falling real wages, rising poverty levels and falling real output

4. Speculation

  • Speculative motives by consumers influence the demand for financial assets
  • People don’t always know all the future values and risks in a Financial Market; hence ‘Market Bubbles’ occur as market values are driven up much higher than their true values
  • Shareholders will ‘speculate’ whether they think assets will increase or decrease in value and act accordingly

5. Lack of Competition

  • Because there are a small number of financial institutions dominating the Financial Market, the likelihood of market players colluding is high
  • This may lead to ‘Market Rigging’ where asset prices become fixed


Quick Fire Quiz – Knowledge Check

1. Define ‘Market Failure in the Financial Sector’ (2 marks)

2. Identify and explain five types of Market Failure in the Financial Sector (10 marks)


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