Economic bubble

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Image:The Way to Grow Poor, The Way to Grow Rich -- Currier & Ives 1875.jpg An economic bubble occurs when speculation in a commodity or asset class causes the price to increase, thus producing more speculation. The price of the good then reaches absurd levels and the bubble is usually followed by a sudden drop in prices, known as a crash or a bubble burst.

Economic bubbles are generally considered to have a negative impact on the economy because they cause misallocation of resources into non-optimal uses. In addition, the crash which usually follows an economic bubble can destroy a large amount of wealth and cause continuing economic malaise as was the case of the Great Depression in the 1930s for much of the world and the 1990s for Japan.

Another important aspect of economic bubbles is their impact on spending habits. Participants in a market with goods that are overvalued, like the housing market in the United Kingdom, Spain and parts of the United States, spend more because they "feel" richer (the Wealth Effect). When the bubble inevitably pops, those who held on usually experience an opposite feeling of poorness.

When the bubble occurs in equity markets, it is called a stock market bubble. It is usually very difficult to differentiate a stock market bubble from an ordinary bull market except in hindsight.

1 Causes
2 Examples
3 See also
4 External links

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Causes

The cause of bubbles is disputed. Some regard bubbles as related to inflation and thus believe that the causes of inflation are also the causes of bubbles. Others take the view that there is a "fundamental value" to an asset, and that bubbles represent a rise over that fundamental value, which must eventually return to that fundamental value. There are chaotic theories of bubbles which assert that bubbles come from particular "critical" states in the market based on the communication of economic actors. Finally, others regard bubbles as a necessary consequence of irrationally valuing assets solely based upon their returns of the recent past without regard to fundamentals.

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