Introduction
- Stock exchanges are vital components of financial markets worldwide, serving as platforms where individuals and institutions trade securities like stocks and bonds.
- They play a central role in capital allocation, wealth creation, and the functioning of modern economies.
Key Functions of Stock Exchanges
- Facilitating Trading: Stock exchanges provide a structured marketplace for buying and selling financial instruments.
- Price Discovery: They establish fair market prices through the interplay of supply and demand.
- Capital Allocation: Stock markets allocate capital from investors to businesses for growth and expansion.
- Regulation: Exchanges enforce rules and regulations to ensure transparency, fairness, and investor protection.
Major Stock Exchanges Around the World
- New York Stock Exchange (NYSE) in the United States.
- Frankfurt Stock Exchange in Germany.
- Tokyo Stock Exchange in Japan.
- Bombay Stock Exchange (BSE) in India.
- Shanghai Stock Exchange in China.
- London Stock Exchange (LSE) in the United Kingdom.
Stock Market Indices
- Indices like the S&P 500, Dow Jones, or NASDAQ Composite represent the collective performance of groups of stocks.
- They serve as benchmarks for assessing overall market health and trends.
Stock Exchange Theories and Concepts
Efficient Market Hypothesis (EMH)
- EMH suggests that stock prices fully reflect all available information, making it impossible to consistently outperform the market through analysis or prediction.
- Three forms of EMH:
- Weak Form: Past price and volume information is already reflected in prices.
- Semi-Strong Form: All publicly available information is reflected in prices.
- Strong Form: All information, public and private, is reflected in prices.
- Example: If a company announces strong earnings, its stock price should quickly adjust to the new information, making it difficult to profit from this knowledge.
Random Walk Theory
- This theory is closely related to EMH and suggests that stock price movements are random and unpredictable.
- In a perfectly efficient market, stock prices would follow a “random walk,” meaning future price changes are unrelated to past price changes.
- Example: The idea that flipping a coin is unpredictable, just like predicting stock price movements in an efficient market.
Bubbles and Speculative Manias
- Bubbles occur when asset prices rise significantly above their intrinsic value due to irrational exuberance and speculative buying.
- Investors often succumb to “irrational exuberance,” as described by economist Robert Shiller.
- Example: The dot-com bubble of the late 1990s saw technology stocks trading at astronomical valuations before crashing.
Resource Allocation: Connecting Capital to Businesses
Definition
- Resource allocation involves directing available resources, such as capital, labor, and materials, to various uses within an economy.
- It addresses the critical questions of what, how, and for whom to produce goods and services.
Scarcity and Opportunity Cost
- Scarcity arises from limited resources facing unlimited wants and needs.
- Opportunity cost is the value of the next best alternative foregone when a choice is made.
- Example: Choosing between going to a movie or studying for an exam; the opportunity cost is the missed entertainment or a lower exam score.
The Economic Problem
- The economic problem stems from scarcity, necessitating choices to allocate resources efficiently.
- Example: An automobile manufacturer must decide how to allocate resources to produce different car models.
Resource Allocation Theories
- Marginal Benefit-Marginal Cost Principle: Resources are allocated where marginal benefit exceeds marginal cost.
- Principle of Comparative Advantage: Resources are allocated based on comparative advantage to maximize efficiency in trade.
- Law of Diminishing Marginal Returns: As more resources are allocated to a specific use, the additional benefit decreases.
