Posted: August 12th, 2013
A bubble market refers to a trade in assets or products that have inflated values. Bubble markets may arise without bounded rationality, speculation or uncertainty. Bubbles occur in key sectors such as the stock market and real estate. They are identified when there is a sudden plunge in prices in the market. Such a plunge is called a bubble burst or a crash. The bubble undergoes a burst or boom, which is a sign of a positive feedback methodology. Negative feedback mechanism is used in determining equilibrium price with the existing normal market conditions. In an economic bubble, prices fluctuate erratically and might make it difficult for prediction in terms of demand and supply. Bubbles can be short-term and last less than ten years or long-term lasting more than a decade.
Market bubbles are caused by a variety of factors, which are disputed among economists. Bubbles are connected to inflation and therefore it is believed the aspects that cause inflation also cause the occurrence of bubbles (Binswanger, 2001). Some experts believe that the fundamental value of the bubbles and assets are a representation of an increase in the same fundamental value. There are some theories that explain the formation of bubble market. According to the theories, bubbles arise from some critical conditions within the market originating from communication among economic players. Long-term bubbles may result from an organized misperception of the total value of some goods and services and prolonged manipulation of records of finance by governments that are considered powerful.
Some methods can be applied by governments to prevent economic bubbles. Economic bubbles that affect the national economy can be prevented by identifying a lender of last resort. This lender will provide resources or money to improve the situation and prevent investors from leaving the country. For instance, the USA acted as a lender of last resort during the 1990s by providing aid to other states and international organizations. Governments should also regulate leverage pockets such as trade brokers by making increments in margin requirements. Banks can also be encouraged to make risk models that will comprise every actual economic sector and get risk-adjusted weights that are internal together with leverage ratios.
Bubble markets can have adverse effects on an economy. Bubbles generally have a negative impact on the economic status of a state because they have the tendency of causing errors in calculating resources for uses that are non-optimal. The wealth effect caused by bubbles makes participants in the market overspend because of the overvalued assets (Raines, et al 2000). This was the case with the housing market in the USA. Some scholars view bubbles to cause long periods of premiums with low risks therefore protracting the dip in asset price deflation. This happened during the Great Depression of 1930s. An effect of a bubble not only affects the nation’s economy but also threatens trade between borders and consequently international trade. An example, of an economic bubble was experienced in Japan’s economy in the 1990swhich led to the deregulation of banks.
A bubble market is an extensive aspect of economics that is still under study. However, there is a need to identify the main causes of bubble markets to prevent economies from failing especially in major sectors of the economy. Studies are still being undertaken to tackle this issue. The American real estate bubble is a clear indication of the effects a market bubble can have on the economy. Countries have to establish concrete policies that will prevent market bubbles and safeguard their economy.
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