Misallocation essentially means that the resources available to an economy or globally are not used in the best way they could which results in loss of output and well being since there was other better option how to use the resources than in the way they are currently being used.

There are multiple and wide-range factors contributing to misallocation. Misallocation is a type of market failure and the term itself, in a way everything that is not a perfect competition is misallocation, since there is a type of market failure or inefficiency at place. Therefore all the causes of imperfect competition are also causes of misallocation:

• imperfect information
• moral hazard
• trade barriers
• entry and exit costs
• natural monopoly
• government corruption
• externalities

A situation in which a malfunctioning financial system contributes to misallocation of resources is for example when investors engage in excessive speculation activity, thereby influencing the prices that are supposed to serve as information about a real value and scarcity of a resource and instead now reflect only fake value created by artificially induced increases or decreases in demand. This provides an incentive for other investors to put more or less of their investments into a particular asset simply because of its increase or decrease of financial value not because of real changes. Such activity can even cause a bubble, and when the bubble bursts the economy is often faced with recession. However, even if it does not lead to recession and large bubble, it is still misallocation of resources since the investors could have allocated their money in better resources and better opportunities.