I've recently been interested in economics and I admit that my understanding concerning it is limited. However my question is if investing in stocks is good for the economy. From my understanding, it is just the redistribution of ownership and wealth from individuals. The businesses are not gaining money, and so profit can be gained there. It seems that it would be substantially better for the economy to purchase products directly from the company, so that the businesses may gain money from consumer spending.
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2 Answers
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The means by which purchasing stock effects economic growth is not as clear as purchasing companies' goods. Nonetheless, there is tremendous benefit for firms (and hence the economy at large) when one decides to purchase their stock, to help understand this I recommend Why Do Companies Care About Their Stock Prices?
First in their IPO, the capital gained they can invest in R&D - as you will learn, some models posit technological shocks are the only effects on long-term economic growth
Second they continue to benefit from a high stock price in the secondary market with stronger financing and M&A's, and can continue to issue more stock at a higher price will yield more value which they will hopefully use to fund further R&D!
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$\begingroup$ Thanks for the response. I read that article you supplied. I see how an IPO can affect a company's wealth, however it seems that it's kind of just a kick starter. Is this correct? Also your second point, at least in the way that I read it, assumes that companies can issue stock whenever. I thought that companies do not interact with stock after their IPO? $\endgroup$– EconomicCommented May 8, 2016 at 5:48
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$\begingroup$ Hi, this second question is better asked on one of the two Finance stack-exchanges, nonetheless the following answer adds some detail to offering stocks after an IPO: money.stackexchange.com/a/18844 $\endgroup$– SunhwaCommented May 8, 2016 at 12:56
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$\begingroup$ Yes, firms issue stocks aft the IPO in SEO's, they also sometimes buy other firms by issuing stock to the other firm's shareholders. $\endgroup$– Fix.B.Commented May 11, 2016 at 2:46
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Interesting question. Buying goods seems to directly increases output of those goods, while buying stocks doesn't seem to. It makes sense.
Some key issues to notice:
Buying a stock is very much like saving. You are effectively giving money to an entrepreneur to build a firm.
Unless there is something else going on, when you save, you put the money in the bank. The bank then less it to a firm. The firm then buys an investment good with that money. So the decision of buying a stock vs. consuming goods is effectively a decision between buying consumption goods and investment goods.
Investment increases the future output of the economy.
Typically, economists don't think about individuals as trying to improve their country's economic growth. Instead, they think of how an economic system, rules, institutions, etc, generate growth. Importantly, the assumption is that the growth is the result of everybody acting in accordance to their own private incentives, not the result of people trying to help their country's economy grow.
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$\begingroup$ Thanks for the response. I still however have a few questions. In concerning your first claim, you said, "you are effectively giving money to an entrepreneur to build a firm". My understanding is limited, but I thought that companies do not have any interaction with their stocks besides their IPO. In this way I do not see how a company can use its stock to increase its wealth. Furthermore, can you elaborate on how "investment increases the future output of the economy". $\endgroup$– EconomicCommented May 8, 2016 at 5:42
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$\begingroup$ Investment increases the future size of the economy because because the economy's output is produced with capital and labor. Investment increases the amount of capital the economy has to produce goods and services. $\endgroup$– Fix.B.Commented May 8, 2016 at 18:49
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$\begingroup$ You are right that there is not necessarily a direct link between buying a stock and the entrepreneur having more money. In an IPO, you are paying the entrepreneur to buy a little bit of the firm, or you might be adding to the capital of the firm if its issuing shares. Firms do issue shares after their IPO, mostly through SEO's (seasoned equity offerings). But even if you buy somebody's stock you are increasing the pool of money that is devoted to buying stocks. Also, your purchase increases the price of equity, which makes it more profitable for entrepreneurs to make new firms and sell them. $\endgroup$– Fix.B.Commented May 8, 2016 at 20:53