Market Bubbles

Events Leading to Bursting a Bubble

The bubble bursts when one or more of several possible events occur: First, wealth available to purchase the bubble may become relatively unavailable, whether due to actual availability or to extraction cost, so that demand slackens from potential purchasers. Because the run-up occurs over such a relatively short period, there is little chance for the market itself to expand. Although in the initial, slower run-up many new entrants may arrive, in the bubble's later stages, the market participants who are present and would invest are already fully engaged in the bubble. At least from the perspective of the practical limits seen in historical contexts, it is not feasible to bring in more distant participants to replace those who are “topped out.” Thus, as the capital supply slackens or becomes too costly, demand plummets and the bubble collapses.

Second, qualities of the commodity may be shown as not unique, not scarce, and/or substitutable. Or the commodity itself may be revealed as different in character from its social perception, or even to be false or nonexistent, as in a scam. Indeed, the commodity's market may be revealed publicly as a bubble, sparking immediate divestiture of holdings and market collapse. Thus, the bubble may collapse if the special, demand-producing character of the commodity changes.

Third, natural or scheduled deadlines may cause investment to slacken as the deadlines near; market investors begin to exit to capture their gains, demand evaporates, and the price goes into free fall. This was one reason for the collapse of Tulipomania (see below).

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