Bubble Economy

October 13, 2010More Economicsby EconomyWatch

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Bubble Economy is an economy in which trade takes place in large volumes with a discrepancy between the price and the intrinsic value of the product. The intrinsic value reflects the fair value, which takes into account the hypothetical calculation of the risks and future returns. The prices in economic bubble waver easily and cannot be calculated only in terms of demand and supply. The economic bubble is normally followed by a period of deterioration of prices. This crashing phenomenon is known as bubble burst or crash. The boom and the bust period in bubble economy are considered to be a positive feedback mechanism.

Bubble economy can lead to disastrous consequence as it occurred in the 1930s in the form of Great Depression and during the 1990s in Japan. The condition misallocates resources. The period of crash following this condition adds to the devastation. It is seen that this economic condition has far fetched effects.

This phenomenon also casts a negative impact on the buying capability of the richer class. They spend more for the products that might be a trifle. The housing market in US, UK, Spain and Australia is an example of this kind of market. The bursting of the bubble aggravates economic slowdown. The occurrence of this kind of phenomenon in the stock market is known as stock market bubble, which is usually difficult to differentiate from an ordinary bull market.

Reasons for the occurrence of Bubble Economy

The reasons behind the occurrence of such a phenomenon can be various according to the experts. The first one is the ‘greater fool’s theory’. According to which a buyer buys a product at a higher rate than its actual worth and waits to sell it off to some other person at an even higher rate. Another school of experts believe that it occurs when the number of potential buyers increase. In an economic condition where people have lots of disposable money this type of situation can occur. However, other experts observe that this situation may arise due to the avarice and irrationality of bullish investors. Therefore it can be deduced that there is no unanimity in the observations of experts regarding the cause of bubble economy. But it is a common belief that all assets have a fundamental value and however bubble takes place the value of those assets again return to that value.