Stock Market and MacroeconomyContdContd..Tracking the stock marketTracking..Explaining Stock Prices—Step #1: Characterize The MarketStep #2: Find The EquilibriumFigure 1: The Market For Shares of Fedex CorporationStep #3: What Happens When Things Change?Slide 10Figure 2a: Shifts in the Demand for Shares CurveFigure 2b: Shifts in the Demand for Shares CurveFigure 3: The Two-Way Relationship Between The Stock Market and the EconomyHow the Stock Market Affects the EconomyThe Wealth EffectThe Wealth Effect and Equilibrium GDPSlide 17Figure 4: The Effect of Higher Stock Prices on the EconomyHow the Economy Affects the Stock MarketWhat Happens When Things Change?Figure 5: Three Types of ShocksA Shock to the EconomyA Shock To the Economy and the Stock Market: The High-Tech Boom of the 1990sA Shock To the Economy and the Stock Market: The High-Tech Boom of the 1990sA Shock to the Economy and the Stock Market: The High-Tech Bust of 2000 and 2001The Fed and the Stock MarketSlide 27Slide 28Figure 6: The Fed’s Problem In 2000: An AS-AD ViewFigure 7: The Fed’s Problem in 2000: A Phillips Curve ViewSlide 31Stock Market and Macroeconomy Share of stock is a private financial asset, like a corporate bondBoth are issued by corporations to raise funds, both offer future payments to their owners but what is the main difference between these two?When a firm issues new shares of stock- called public offerings – sale of which generates funds for the firm- newly issued shares can be sold to someone elseVirtually all the shares traded in the stock market are previously issued- trading doesn’t involve the firm that issued the stockContdBut why the firm still concerned about the price of its previously issued share? - first, the firm’s owners-its stockholders-want high share prices because that is the price they can sell at -second, previously issued shares are perfect substitute of new public offerings – ------------therefore, the firm cannot expect to receive higher price for its new shares than the going price on its old shared ---what is the result then??Contd..In 1983, only 19 percents of Americans owned share of stocks either directly or through mutual funds(?) – in 2003, almost 50% American owned stockYou own a share of stock implies you own part of the corporation-own a fraction of the company’s total stockyou are entitled to a particular percent of the firm’s after tax profitHowever, firms do not pay all their after-tax profit to share holders- some is kept as retained earnings for later use of the firmThe part of profit distributed to share holders is called dividendsAside from dividends, usually more important reason to holding stocks is to enjoy capital gains – return someone gets when they sell a stock at a higher price than they paid for itTracking the stock marketFinancial market is so important that stocks and bonds are monitored on a continuous basisYou can find out the value of a stock instantly just by checking with a broker or logging onto a website Daily news paper or specialized financial publication such as Wall Street Journal or Financial Times report daily informationIn addition to that, there are many stock market indicesTracking..Oldest and most popular average Dow Jones Industrial Average (DJIA)-tracks prices of 30 of the largest companiesAnother popular average Broader Standard & Poor’s 500 (S&P 500)NASDAQ index tracks share prices of about 5,000 mostly newer companies whose shares are traded on NASDAQ stock exchangeOften, stock market averages will rise and fall at the same time, sometimes by the same percentageIn spite of falling stock prices in 2000 and 2001, the last decade was good for stocksExplaining Stock Prices—Step #1: Characterize The MarketPrice of a share of stock—like any other— is determined in a marketWe’ll characterize the market for a company’s shares as perfectly competitiveView stock market as a collection of individual, perfectly competitive markets for particular corporations’ sharesMany buyers and sellersVirtually free entryStep #2: Find The EquilibriumLike all prices in competitive markets, stock prices are determined by supply and demandHowever, in stock markets, supply and demand curves require careful interpretationsFigure 1 presents a supply and demand diagram for shares of Fedex CorporationOn any given day, number of Fedex shares in existence is just the number that the firm has issued previouslyJust because 302 million shares of Fedex stock exist, that does not mean that this is the number of shares that people will want to holdPeople have different expectations about firm’s future profitsAt any price other than $90 per share, number of shares people are holding (on the supply curve) will differ from number they want to hold (on the demand curve)Only at equilibrium price of $90— people satisfied holding number of shares they are actually holdingStocks achieve their equilibrium prices almost instantlyFigure 1: The Market For Shares of Fedex CorporationNumber of SharesPrice per ShareES$1209060D302 millionStep #3: What Happens When Things Change?Supply curve for a corporation’s shares shifts rightward whenever there is a public offeringThe changes we observe in a stock’s price—over a few minutes, a few days, or a few years—are virtually always caused by shifts in demand curvewhat causes these sudden changes in demand for a share of stock?In almost all cases, it is one or more of the following three factorsChanges in expected future profits of firmAny new information that increases expectations of firms’ future profits will shift demand curves of affected stocks rightward Including announcements of new scientific discoveries, business developments, or changes in government policyMacroeconomic FluctuationsAny news that suggests economy will enter an expansion, or that an expansion will continue, will shift demand curves for most stocks rightwardChanges in the interest rateA rise (drop) in the interest rate in the economy will shift the demand curves for most stocks to the left (right)Step #3: What Happens When Things Change?Even expectations of a future interest rate change can shift demand curves for stocksSuch an event occurred on February 27, 2002, when Fed Chair Greenspan announced that it appeared economy was recovering from its