Stock Prices: S&P 500
Connections


Connections to Key Topics with Additional Resources

Topic Connections and Additional Resources
Production and Costs

The S&P 500 index tends to be inversely related to interest rates. The reason is that higher interest rates raise the cost of borrowing money, and all else equal higher costs result in lower profits and stock values. Likewise any other economy-wide factor that raises costs will tend to cause the S&P 500 to drop.

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Profit Maximization and The Firm

Shareholders in a capitalist economic system seek maximum profit. Yet large companies with publicly traded stock, such as those represented in the S&P 500, feature a separation of corporate ownership (stockholders) and control (management). Increasingly many large corporations pay a large portion of executive salaries in stocks or stock options in order to align the incentives of managers with those of shareholders.

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Market Failure, Regulation, and Public Choice

Pollution and monopoly are examples of market failures that occur in instances where Adam Smith's invisible hand of the market fails to yield efficient outcomes. Environmental laws and antitrust policies may resolve these market failures, but they also can reduce corporate profitability. Thus the S&P 500 index will often times be inversely related to levels of economic regulation.

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Income Distribution and Poverty

The returns to capital, as measured by stock indexes such as the S&P 500, far exceeded the returns to labor in much of the 1980's and 1990's. With higher return comes higher risk, however, and many investors could only watch as the market declined sharply in the years surrounding the most recent recession in 2001. With greater levels of investment by average working people in the markets through company sponsored 401K plans, many more Americans than ever before hold a stake in the fluctuations of the stock markets.

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Aggregate Demand/ Aggregate Supply

Sharp gains in the stock market, can contribute to an increase in aggregate consumer expenditures. A positive spending shock will shift out aggregate expenditures and aggregate demand, and thus can increase real GDP and the price level. Conversely, when the S&P index is down, such as it was during much of 2001-30, consumer confidence also plummets, as many people view the stock market as a barometer of general economic strength. This can reduce the growth rate of aggregate demand and reduce the rate of economic growth.

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Money and The Financial System

The issuance of stock is one of the mechanisms by which firms raise external funds for capital investment and expansion (the other being borrowing, such as by issuing bonds). A key difference between stocks and bonds is that stockholders are owners of the firm, while bondholders are lenders and do not have an ownership stake.

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International Finance

In our present globalized economy, investors search the world for stable and lucrative financial returns. Consequently an economic shock such as the Asian financial crisis in 1997 and 1998 caused investment capital to flow away from unstable markets. To prevent capital flight, central banks may raise interest rates to compensate investors for elevated risk, but higher interest rates can trigger a recession.

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Comparative Economic Systems Factories and other production facilities are owned by government rather than by private investors in traditionally communist countries such as the former Soviet Union. Financing for capital investment is provided by the government, and consequently there are no stock markets. Unlike in the United States, where private investors hold most of the shares of companies on the New York Stock Exchange, stock markets in countries like Japan and Germany are dominated more by commercial banks. Securities laws in the United States attempt to create buffers between the operations of investment and commercial banks.

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Government and the Economy Following the corporate governance debacles linked to Enron and WorldCom, the Sarbanes-Oxley Act of 2002 was passed to combat corporate and accounting fraud that was undermining investor confidence in U.S. equities. The Sarbanes-Oxley Act, and the Securities and Exchange Commission rules promulgated to implement it, bans such practices as companies providing personal loans to directors or managers, and auditors also providing management consulting services to a firm.

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Perfect Competition One of the requirements for a perfectly competitive market is that there be many buyers and sellers, each of whom is small in size relative to the overall market. While this requirement is at times violated in nearly all real-world markets, the large stock markets -- and trading in S&P 500 stocks -- frequently feature large numbers of buyers and sellers interacting in a highly competitive environment.

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