4.4 The Financial Sector

Question 1

What its a financial market?

Answer 1

It is where buyers and sellers can trade and sell a range of services and assets fundamentally monetary in nature

Question 2

What are 5 roles of financial market?

Answer 2

Facilitate savings
Lend to individuals and firms
Provide a market for equities
Provide forward markets
Allow goods and services to be exchanged

Question 3

How can asymmetric information cause market failure in the financial sector?

Answer 3

It can cause banks to sell individuals products they dont need or things which are riskier than advertised. This is because the banks have more knowledge than the individuals. This can also happen between financial regulators and financial institutes, as the institutions have no incentive to help regulators

Question 4

How can externalities cause market failure in the financial sector?

Answer 4

Financial institutes needing to be bailed out had a huge external cost to the taxpayer

Question 5

How does moral hazard lead to market failure?

Answer 5

Workers know that the worst they can happen if they make a wrong move is that they get fired but it can cost the firms they work for millions. Also, the banks know that the central bank will bail them out if necessary

Question 6

How can speculation and market bubbles lead to market failure?

Answer 6

Speculation can causes extreme volatility with large highs and large lows, which can cause assets to be under or over valued, also leading to herd behaviour where people follow what everyone else is doing x

Question 7

What is the role of central banks?

Answer 7

Control Monetary Policy
Regulate the financial industry
Banker to other banks
Banker to the government