I’ve tried to do my own research but I just can’t seem to grasp the concept. How do bubbles form? Why doesn’t the “invisible hand” of the market keep this from happening? Wouldn’t supply/demand naturally control prices and keep this from happening? Why do some markets form bubbles when others, like the diamond industry, don’t?
In: Economics
On the invisible hand — the big assumptions with this are rationality and information symmetry. That is, the invisible hand works to produce the optimal outcome GIVEN that all players are rationale and everyone knows what everyone else knows. When these conditions aren’t met, you have a market failure i.e. the market forces (invisible hand) fail to produce the optimal outcome. Bubbles form when some market players think the value of the thing will continue to go up, when in fact they don’t know (or irrationally refuse to believe) that the price is already way above the true value of the thing.
EDIT: information symmetry, not asymmetry.
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