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Asymmetric information
Moral hazard
Externalities
Speculation
Market rigging

","mcqOptions":[{"text":"

Asymmetric information
Moral hazard
Externalities
Speculation
Market rigging

","correct":true,"explanation":"These are the five main sources: information gaps, risk-taking after protection, third-party effects, profit-driven trading, and manipulation or collusion."},{"text":"

Adverse selection
Moral hazard
Externalities
Speculation
Market rigging

","correct":false,"explanation":"Adverse selection is a specific form of information failure, but it is not usually listed separately among the five main sources; asymmetric information is the broader category."},{"text":"

Asymmetric information
Price discrimination
Externalities
Speculation
Market rigging

","correct":false,"explanation":"Price discrimination concerns charging different consumers different prices and is not a main financial-market failure source; moral hazard belongs in the list instead."},{"text":"

Asymmetric information
Moral hazard
Economies of scale
Speculation
Market rigging

","correct":false,"explanation":"Economies of scale can lower average costs and are not inherently market failure; externalities, where third parties are affected, are the relevant missing source."}]},{"id":"f22e4163-87f0-44ab-9044-dce5849c10c1","cardType":"cloze","points":null,"front":"[ ] occurs when one party has more or better information than the other.","back":"Asymmetric information occurs when one party has more or better information than the other.","mcqOptions":[{"text":"Asymmetric information","correct":true,"explanation":"This occurs when one participant in a transaction has more or better information than the other, potentially causing poor decisions or misallocated resources."},{"text":"Moral hazard","correct":false,"explanation":"Moral hazard concerns increased risk-taking after protection is provided; the information imbalance described here is asymmetric information."},{"text":"Adverse selection","correct":false,"explanation":"Adverse selection occurs before a contract when riskier participants are more likely to seek a deal; the broader information gap is asymmetric information."},{"text":"Market rigging","correct":false,"explanation":"Market rigging involves manipulating prices or benchmarks, rather than one party possessing better information than another in a transaction."}]},{"id":"c1a3bf78-11a2-4c0c-8d4b-1fc1c1ad8886","cardType":"cloze","points":null,"front":"[ ] occurs when, before a contract, the riskier party is most likely to seek the deal.","back":"Adverse selection occurs when, before a contract, the riskier party is most likely to seek the deal.","mcqOptions":[{"text":"Adverse selection","correct":true,"explanation":"Before a contract, risky applicants are more likely to seek insurance or lending because they know their risk better than the provider."},{"text":"Moral hazard","correct":false,"explanation":"Moral hazard arises after a contract, when protection changes behaviour and encourages greater risk-taking; this before-contract problem is adverse selection."},{"text":"Asymmetric information","correct":false,"explanation":"Asymmetric information is the general information imbalance, whereas the specific pre-contract tendency for riskier parties to seek deals is adverse selection."},{"text":"Market bubble","correct":false,"explanation":"A market bubble is an asset price far above fundamental value, not a pre-contract problem involving riskier applicants."}]},{"id":"899372d2-7ea1-4439-901c-4c1a8cce7773","cardType":"basic","points":1,"front":"When does adverse selection arise?","back":"Before a contract.","mcqOptions":[{"text":"Before a contract.","correct":true,"explanation":"Adverse selection occurs before agreement because the riskier party is more likely to seek the contract when information is unevenly distributed."},{"text":"After a contract.","correct":false,"explanation":"After-contract risk-taking describes moral hazard. Adverse selection occurs before the contract, when riskier parties are more likely to apply."},{"text":"During a contract.","correct":false,"explanation":"The key timing is before agreement, when applicants’ risk types influence who seeks the deal; during-contract behaviour is not the defining feature."},{"text":"After a claim is paid.","correct":false,"explanation":"Claim payment is not the relevant timing distinction. Adverse selection happens before the contract, while moral hazard follows protection."}]},{"id":"0d10420d-d6b9-40f3-9731-577c7f851997","cardType":"cloze","points":null,"front":"[ ] is the tendency to take greater risks once protected from the consequences.","back":"Moral hazard is the tendency to take greater risks once protected from the consequences.","mcqOptions":[{"text":"Moral hazard","correct":true,"explanation":"Moral hazard describes behaviour becoming riskier after protection, because the protected person no longer bears all the consequences of failure."},{"text":"Adverse selection","correct":false,"explanation":"Adverse selection happens before a contract, when riskier parties are more likely to seek an agreement; post-protection risk-taking is moral hazard."},{"text":"Asymmetric information","correct":false,"explanation":"Asymmetric information is the underlying imbalance in knowledge, not specifically the increased risk-taking that follows protection."},{"text":"Negative externality","correct":false,"explanation":"A negative externality is a cost imposed on third parties outside a transaction; it does not describe protected parties changing their risk behaviour."}]},{"id":"bf14d494-6b11-4431-a5c6-22eb2e30132d","cardType":"basic","points":1,"front":"When does moral hazard arise?","back":"After a contract.","mcqOptions":[{"text":"After a contract.","correct":true,"explanation":"Moral hazard arises after agreement, when insurance, guarantees, or expected rescue reduces the consequences faced by the decision-maker."},{"text":"Before a contract.","correct":false,"explanation":"Before-contract selection of riskier applicants is adverse selection. Moral hazard concerns changed behaviour after protection has been agreed."},{"text":"During a contract.","correct":false,"explanation":"Although behaviour may change while a contract is active, the defining distinction is that moral hazard follows the contract being established."},{"text":"Before a claim is assessed.","correct":false,"explanation":"Claim assessment is not the relevant boundary. Moral hazard follows protection, whereas adverse selection occurs during the earlier application stage."}]},{"id":"0feef68d-0c39-468e-a380-9c79d2210d8d","cardType":"cloze","points":null,"front":"A cost imposed on third parties outside a financial transaction is a [ ].","back":"A cost imposed on third parties outside a financial transaction is a negative externality.","mcqOptions":[{"text":"negative externality","correct":true,"explanation":"A negative externality is a harmful cost imposed on people outside the transaction, such as wider financial disruption affecting unrelated firms and households."},{"text":"positive externality","correct":false,"explanation":"A positive externality creates benefits for third parties. The question describes a cost, so the externality is negative."},{"text":"moral hazard","correct":false,"explanation":"Moral hazard is increased risk-taking after protection, not a cost imposed on uninvolved third parties."},{"text":"market rigging","correct":false,"explanation":"Market rigging manipulates prices or benchmarks through collusion or deception; it is not the general term for third-party transaction costs."}]},{"id":"225654d7-e23f-4d90-9543-dc19a24c9242","cardType":"cloze","points":null,"front":"Buying assets to profit from price changes rather than their use or income is [ ].","back":"Buying assets to profit from price changes rather than their use or income is speculation.","mcqOptions":[{"text":"speculation","correct":true,"explanation":"Speculation means buying an asset mainly to profit from future price movements rather than from using it or receiving its income."},{"text":"investment","correct":false,"explanation":"Investment generally focuses on productive assets or future income, whereas buying mainly to profit from price changes is speculation."},{"text":"market rigging","correct":false,"explanation":"Market rigging involves deliberate manipulation or collusion to influence prices; the definition here describes trading motive, namely speculation."},{"text":"diversification","correct":false,"explanation":"Diversification spreads funds across assets to reduce risk. It does not specifically mean purchasing assets for price-change profits."}]},{"id":"5cc974ce-7762-435c-b301-f635d381f83f","cardType":"cloze","points":null,"front":"When speculation pushes an asset's price far above its fundamental value, it creates a [ ].","back":"When speculation pushes an asset's price far above its fundamental value, it creates a market bubble.","mcqOptions":[{"text":"market bubble","correct":true,"explanation":"A market bubble occurs when speculative demand drives an asset price substantially above its fundamental value, creating a risk of a sharp correction."},{"text":"negative externality","correct":false,"explanation":"A negative externality is a cost imposed on third parties. The excessive asset price described here creates a market bubble."},{"text":"market failure","correct":false,"explanation":"Market failure is the broad outcome of inefficient resource allocation; the specific speculative price distortion is a market bubble."},{"text":"price ceiling","correct":false,"explanation":"A price ceiling is a legal maximum price imposed by government. Speculation pushing prices above value is unrelated to that control."}]},{"id":"63a9a4d6-b7bd-4d80-8273-2602d045b197","cardType":"basic","points":3,"front":"Which three regulations can help correct financial market failure?","back":"

Capital requirements
Deposit insurance
Conduct regulation

","mcqOptions":[{"text":"

Capital requirements
Deposit insurance
Conduct regulation

","correct":true,"explanation":"Capital requirements improve banks’ loss-absorbing capacity, deposit insurance protects confidence, and conduct regulation limits harmful behaviour."},{"text":"

Price controls
Deposit insurance
Conduct regulation

","correct":false,"explanation":"Price controls are not the standard response to financial-sector failure; capital requirements strengthen bank resilience and should replace them."},{"text":"

Capital requirements
Import quotas
Conduct regulation

","correct":false,"explanation":"Import quotas restrict international trade and do not protect banking stability; deposit insurance is the relevant financial regulation missing here."},{"text":"

Capital requirements
Deposit insurance
Subsidies for speculation

","correct":false,"explanation":"Subsidising speculation would encourage risky price-chasing and worsen instability; conduct regulation is intended to constrain misconduct."}]},{"id":"54721150-cf56-48d3-8001-d08b2ff27869","cardType":"basic","points":3,"front":"Give two examples of market rigging.","back":"

Insider dealing
Fixing benchmark interest rates, such as LIBOR

","mcqOptions":[{"text":"

Insider dealing
Fixing benchmark interest rates, such as LIBOR

","correct":true,"explanation":"Insider dealing uses confidential information unfairly, while benchmark fixing manipulates important reference rates; both distort market outcomes."},{"text":"

Insider dealing
Changing market opening hours, such as the London session

","correct":false,"explanation":"Changing opening hours is an administrative decision, not rigging. Fixing benchmark interest rates, such as LIBOR, is the relevant manipulation."},{"text":"

Deposit insurance
Fixing benchmark interest rates, such as LIBOR

","correct":false,"explanation":"Deposit insurance protects savers and supports confidence; it is not rigging. Insider dealing is the missing example of manipulation."},{"text":"

Capital requirements
Reducing benchmark interest rates, such as LIBOR

","correct":false,"explanation":"Capital requirements are prudential safeguards, not rigging, and a legitimate rate reduction is not necessarily manipulation; insider dealing is required."}]},{"id":"c9fa844c-adce-4016-98b5-fb35ed19ed43","cardType":"basic","points":3,"front":"How does adverse selection misallocate lending?","back":"

Lenders cannot distinguish safe from risky borrowers.
Risky borrowers crowd into the market.
Higher interest rates price out good borrowers.

","mcqOptions":[{"text":"

Lenders cannot distinguish safe from risky borrowers.
Risky borrowers crowd into the market.
Higher interest rates price out good borrowers.

","correct":true,"explanation":"Information gaps hide borrower risk, so risky applicants become overrepresented. Lenders raise rates, which discourages safer borrowers and worsens allocation."},{"text":"

Lenders can distinguish safe from risky borrowers.
Safe borrowers crowd into the market.
Lower interest rates price out risky borrowers.

","correct":false,"explanation":"Adverse selection means lenders cannot identify risk accurately and risky borrowers become overrepresented; higher, not lower, rates drive out good borrowers."},{"text":"

Lenders cannot distinguish safe from risky borrowers.
Safe borrowers crowd into the market.
Higher interest rates price out good borrowers.

","correct":false,"explanation":"The first and third points describe adverse selection, but risky borrowers, not safe borrowers, are attracted disproportionately when risk cannot be identified."},{"text":"

Lenders cannot distinguish safe from risky borrowers.
Risky borrowers crowd into the market.
Lower interest rates price out good borrowers.

","correct":false,"explanation":"The first two effects are correct, but lower rates do not price out good borrowers; adverse selection leads to higher rates that discourage them."}]},{"id":"d210a061-48dc-4fe4-9d99-48bfe77f6fd5","cardType":"basic","points":2,"front":"Why can an expected government rescue cause moral hazard in banks?","back":"Expected rescue shifts failure costs to taxpayers, encouraging reckless lending.","mcqOptions":[{"text":"Expected rescue shifts failure costs to taxpayers, encouraging reckless lending.","correct":true,"explanation":"A perceived bailout reduces the bank’s private downside, transferring losses to taxpayers and weakening incentives to assess lending risks carefully."},{"text":"Expected rescue shifts failure costs to depositors, encouraging reckless lending.","correct":false,"explanation":"A rescue is expected to protect key creditors and transfer much of the failure cost to taxpayers; blaming depositors reverses the moral-hazard mechanism."},{"text":"Expected rescue shifts failure costs to taxpayers, discouraging reckless lending.","correct":false,"explanation":"Taxpayer-funded rescue can encourage reckless lending because banks expect protection; it does not strengthen incentives by itself."},{"text":"Expected rescue shifts profits to taxpayers, encouraging reckless lending.","correct":false,"explanation":"Rescue socialises potential losses rather than transferring profits to taxpayers. That reduced private exposure is what encourages reckless lending."}]},{"id":"f2cadf5f-de9e-45ae-a821-91123a4c9fb5","cardType":"basic","points":2,"front":"How can one large bank's failure disrupt the financial system?","back":"The failing bank spreads contagion, freezing lending across the system.","mcqOptions":[{"text":"The failing bank spreads contagion, freezing lending across the system.","correct":true,"explanation":"Interconnected banks may lose confidence in one another after a major failure, causing withdrawals and a system-wide freeze in lending."},{"text":"The failing bank spreads competition, freezing lending across the system.","correct":false,"explanation":"Competition does not describe the transmission of panic between linked institutions; contagion is the process that can freeze system-wide lending."},{"text":"The failing bank spreads contagion, increasing lending across the system.","correct":false,"explanation":"Contagion transmits financial distress and typically causes banks to restrict credit, so it freezes rather than increases lending."},{"text":"The failing bank spreads confidence, freezing lending across the system.","correct":false,"explanation":"Confidence would generally support lending. A major failure transmits fear and uncertainty through contagion, causing lending to freeze."}]},{"id":"e3e87b49-3435-4ca5-b076-63adfccc6c7e","cardType":"basic","points":2,"front":"How can financial contagion affect the real economy?","back":"Frozen lending harms firms and households in the wider real economy.","mcqOptions":[{"text":"Frozen lending harms firms and households in the wider real economy.","correct":true,"explanation":"Restricted credit prevents firms from investing and households from borrowing or spending, reducing economic activity beyond the financial sector."},{"text":"Frozen lending harms banks and regulators in the wider real economy.","correct":false,"explanation":"Banks and regulators are part of the financial system, whereas the real-economy effects mainly reach firms and households through reduced credit."},{"text":"Frozen lending helps firms and households in the wider real economy.","correct":false,"explanation":"Credit restrictions make investment, working capital, mortgages, and consumption harder to finance, so firms and households are harmed rather than helped."},{"text":"Frozen lending harms firms and households only within the financial sector.","correct":false,"explanation":"Firms and households belong to the wider real economy, so the consequence extends beyond finance; describing it as only financial is incorrect."}]},{"id":"6ec893b9-5f53-4fd0-a4b8-a68156de623e","cardType":"basic","points":3,"front":"How does market rigging cause financial market failure?","back":"Collusion or manipulation distorts prices and erodes trust.","mcqOptions":[{"text":"Collusion or manipulation distorts prices and erodes trust.","correct":true,"explanation":"Rigging prevents prices from reflecting genuine supply and demand and undermines confidence that markets are fair, reducing their efficiency and participation."},{"text":"Collusion or manipulation stabilises prices and erodes trust.","correct":false,"explanation":"Rigging may temporarily control prices, but the economic problem is that it distorts them rather than reliably stabilising genuine market values."},{"text":"Collusion or manipulation distorts prices and builds trust.","correct":false,"explanation":"Manipulation can conceal information and create unfair outcomes, so it undermines trust rather than building confidence in financial markets."},{"text":"Collusion or manipulation improves information and erodes trust.","correct":false,"explanation":"Rigging exploits or conceals information instead of improving its quality; its effects include distorted prices and reduced trust."}]},{"id":"57c1ce94-d77f-4fb1-a7c1-62967d1d680f","cardType":"basic","points":2,"front":"How can a speculative bubble damage the real economy when confidence turns?","back":"Falling confidence causes a price crash that can spill into the real economy.","mcqOptions":[{"text":"Falling confidence causes a price crash that can spill into the real economy.","correct":true,"explanation":"When confidence collapses, investors sell inflated assets, causing prices and wealth to fall sharply. Lower spending, investment and lending then transmit the crash to the real economy."},{"text":"Falling confidence causes a price recovery that can spill into the real economy.","correct":false,"explanation":"A recovery is unlikely when confidence suddenly falls because investors typically sell rather than buy. This causes a price crash, which can reduce wealth, spending, investment and lending."},{"text":"Falling confidence causes a price freeze that can spill into the real economy.","correct":false,"explanation":"The misconception is that falling confidence merely stops prices changing. In a speculative bubble, widespread selling causes a price crash that can then damage spending and investment."},{"text":"Falling confidence causes a price increase that can spill into the real economy.","correct":false,"explanation":"Falling confidence reduces demand for the inflated assets rather than increasing it. Investors sell, causing a price crash that can spread through lower wealth, lending and expenditure."}]},{"id":"3347b624-3e94-4fd4-add0-c26310b32195","cardType":"basic","points":3,"front":"How can financial regulation reduce market failure?","back":"

Curb reckless risk-taking
Limit contagion
Punish market rigging

","mcqOptions":[{"text":"

Curb reckless risk-taking
Limit contagion
Punish market rigging

","correct":true,"explanation":"Regulation can constrain excessive risks, prevent financial distress spreading between institutions and impose penalties for market manipulation. These measures address instability, systemic externalities and abusive conduct."},{"text":"

Encourage reckless risk-taking
Increase contagion
Reward market rigging

","correct":false,"explanation":"These outcomes would intensify financial market failure rather than reduce it. Effective regulation curbs reckless risk-taking, limits contagion between institutions and punishes attempts to rig markets."},{"text":"

Curb consumer saving
Limit competition
Punish market entry

","correct":false,"explanation":"Suppressing saving, competition and entry does not target the relevant financial failures and may reduce efficiency. Regulation should curb reckless risk-taking, limit contagion and punish market rigging."},{"text":"

Encourage asset bubbles
Limit transparency
Punish responsible lending

","correct":false,"explanation":"Promoting bubbles, concealing information and penalising prudent lending would worsen instability and information failure. Regulation instead curbs reckless risk-taking, limits contagion and punishes market rigging."}]},{"id":"9e2ea07e-933e-466e-80f3-f58a859f4edd","cardType":"basic","points":3,"front":"Why might financial regulation be ineffective or inefficient?","back":"

Regulation is costly.
Financial innovation can enable evasion.

","mcqOptions":[{"text":"

Regulation is costly.
Financial innovation can enable evasion.

","correct":true,"explanation":"Designing, monitoring and enforcing rules uses substantial resources, while firms may develop new products or structures that avoid existing rules. Regulation can therefore be inefficient or ineffective."},{"text":"

Regulation is costless.
Financial innovation can prevent evasion.

","correct":false,"explanation":"Treating regulation as costless ignores compliance and enforcement resources, while innovation may create loopholes rather than prevent avoidance. Regulation can be costly and financial innovation can enable evasion."},{"text":"

Regulation is profitable.
Financial innovation can ensure compliance.

","correct":false,"explanation":"Regulation is not necessarily profitable, and innovation does not guarantee that firms obey rules. Its limitations arise because regulation is costly and new financial methods can enable evasion."},{"text":"

Regulation is automatic.
Financial innovation can eliminate failure.

","correct":false,"explanation":"Regulation requires active design, monitoring and enforcement, so it is neither automatic nor free. Innovation can facilitate evasion instead of eliminating market failure, making regulation less effective."}]},{"id":"79912f86-58df-4bc1-a24a-0e1a44615f4f","cardType":"basic","points":3,"front":"What determines whether financial regulation corrects market failure?","back":"Success depends on rule design, enforcement and keeping pace with changing markets.","mcqOptions":[{"text":"Success depends on rule design, enforcement and keeping pace with changing markets.","correct":true,"explanation":"Rules must target the underlying market failure, be enforced effectively and adapt as institutions and products evolve. Weakness in any of these areas can undermine regulatory success."},{"text":"Success depends on rule quantity, advertising and keeping pace with changing markets.","correct":false,"explanation":"Having more rules does not ensure that they are well targeted, while advertising cannot substitute for regulatory action. Success depends on sound rule design, enforcement and adaptation."},{"text":"Success depends on market growth, self-regulation and keeping pace with changing markets.","correct":false,"explanation":"Growth does not show that financial market failures have been corrected, and self-regulation may leave conflicts of interest unresolved. Effective rule design and enforcement are also essential."},{"text":"Success depends on rule design, deregulation and keeping pace with changing markets.","correct":false,"explanation":"Well-designed rules achieve little if they are removed or not applied. Success requires effective enforcement, alongside appropriate rule design and adaptation to changing financial markets."}]}]}],"examCountdown":{"examDate":"2027-05-10","paperLabel":"Paper 1"},"heading":"4.4.2 Market failure in the financial sector","title":"4.4.2 Market failure in the financial sector Flashcards","topbar":{"backHref":"/a-level/economics/edexcel/a/flashcards"},"topicSidebar":"$L38"}]}],"topicId":"1b522fd3-4d67-517b-93ad-2dda8316907d","walled":"$L39"}],"$L3a","$L3b"]