Chapter EMA, Problem 3DS

To determine

To state: The way an asset bubble leads to an economy-wide banking crisis.

Explanation of Solution

The unavoidable failure of asset bubbles drains out the net worth of investors and caused unprotected businesses to fail, possibly touching off a cascade of financial anxiety and debt deflation that can blowout to other parts of the economy leading to a period of lower production and higher unemployment that symbolizes a recession.

Economics Concept Introduction

Introduction:

Asset bubble: In this, the price of an asset is pressed to an irrationally high level due to the potential for further price gains.

Thus, an asset bubble happens when the price of an asset, such as bonds, real estate, stocks, or commodities, grows at a rapid pace without fundamentals, such as similarly fast-rising demand, to validate the price spike.