Why aren't stock bubble crashes just zero sum exchanges of wealth?

External question — Economics Stack Exchange Author: 755 Original post: https://economics.stackexchange.com/questions/51554 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. (I'm not an economics student or anything of the sort) Let's say the total valuation of a country's stocks rises from 1000 to 2000 during year 1, and then "crashes" from 2000 to 1000 in year 2. This prompts everyone to say this was a devastating event because many people lost a lot of money. But ignoring economic growth etc., weren't those two years in the stock market just a zero sum exchange of wealth from people who sold high to people who bought high? I see why people who bought high lost money, but didn't the people who sold high gain an equivalent amount of money? My question is essentially, in the short term is the reason why stock market crashes are so bad (I'm not saying that crashes aren't bad) that it causes great wealth inequality, rather than actually "decreasing the wealth" of an economy?

External answer — Economics Stack Exchange Author: user46157 Original post: https://economics.stackexchange.com/a/57511 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. The transactions on the exchange are zero sum. But when people say that some event wiped out 1 trillion in market value", they're referring to market cap. The problem here is that people use past share transactions to value an entire company. In your example, $2000 was the peak. People refer to peaks, as people like looking at peaks. You don't know how many shares traded at that price of $2000, perhaps just a few. But the money at the peak was never actually there, as it was a so-called inflated valuation.

External answer — Economics Stack Exchange Author: Dan Original post: https://economics.stackexchange.com/a/60369 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. One reason is leverage. The simplest view of a bubble bursting is that (probably wealthy) people or institutions are losing much of the value of assets that they own. However, if investors borrow money in order to speculatively purchase stocks, then a bursting bubble can bankrupt investors and the financial institutions that have lent them money, because they have lost more money than they had in the first place. Bankruptcy of financial institutions can have chaotic and wide-ranging impacts. Even threats to financial institutions can cause a defensive retraction of lending (and increase in the price of lending) that can also cause ordinary businesses to suffer. To dig a bit deeper, it might be useful to distinguish a few different archetypes of a crash: a stock market crash that is based on the fundamentals changing, e.g. an earthquake reduces the values of many companies, and the stock market prices this in, a stock market crash that is irrational, i.e. stock market prices suddently fall even though the fundamentals supported the original prices, and a stock market crash that is correcting a "bubble", i.e. the stock market is adjusting to the realisation that some companies were overvalued. You are asking specifically about (3), but a second answer to your question is that it is hard to insulate the bubble from the rest of the economy. When a stock market makes what could be thought of as a "rational" attempt to correct a misperception or irrational confidence, it tends to do so irrationally, or at least with imprecision. When some stock prices are falling sharply, there is a strong temptation to get out of anything that might get caught up in the crash (even if this move is justified on the basis that "other people" are irrational and will panic and try to sell off an accurately valued stock). If a stock market attempts (3), it is likely get an unhealthy dose of (2) as well. When an ordinary company unexpectedly loses market capitalisation, a potentially very damaging effect is that their ability to raise new finance (by issuing new shares) is compromised. If they don't have the cash reserves to ride this out, they could be in trouble. If they do, or are currently profitable, they may still have to suddenly cut planned investment and job creation.

External answer — Economics Stack Exchange Author: AcePL Original post: https://economics.stackexchange.com/a/60395 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. You are looking at this problem from the wrong end. It is true that transactions are zero-sum outcome - but at a given point in time . This is the problem: the delay in time of outcome of these transactions, where you bought something . So it is quite understandable for a person saving for a pension to get quite frustrated (among other things) to see the value of their stock diminished due to a market crash, as he paid fair price for some asset, but at earlier point of time. But this is the nature of investing in stock - you will see ups and downs, with average still giving a net increase. But it needs the time , and it is again understandable when it's time to retire and to cash out at the wrong point of it. But I would like to raise another point - are the transactions really zero-sum, if one of the parties in the transaction has more information than the other? This fictional scene with fictional characters, which somehow feels extremely realistic, sums up perfectly the issue.