Readers Question: Can you explain what happens to wealth when e.g share price, property prices fall?
Do they just vanish into thin air, or is money just being transferred from one person to another? In other words, are all investment a zero-sum game? What happens when prices rise?
Is there a simple example that can illustrate this concept?
A zero-sum game means that if one person gains, then it has to be matched by an equivalent loss from someone else. No extra output is created, it is merely a question of how the cake is split up.
For example, suppose I buy Euros in exchange Pounds from someone else (and let’s assume zero transaction costs).
- I have an increase in quantity of Euros, the other person see an increase in quantity of Pound sterling.
- If the value of the Euro increases, then I am better off. However, the person who sold Euros will see a decline in the value of their currency holdings.
- If I buy Euros, there is unlikely to be any change in output or welfare for society.
- By correctly predicting an appreciation in the Euro – I have gained at the other persons expense.
- Therefore, foreign currency speculation could be seen as a zero sum game.
Often investing in the stock market may feel like a zero sum game. Suppose, we take the top 100 companies (FTSE-100). One investment fund may pick the best performing companies. These investors will see an increase in their wealth. Another investment fund may pick poorly performing companies, therefore they see a fall in their wealth.
