Purpose of the Stock Market in a Market Economy

by Bryan Keythman, studioD

The stock market consists of stock exchanges and a network of financial institutions through which investors buy and sell shares of stock. A market economy is one that has limited government influence and in which individuals and businesses generally dictate the direction of the economy through their actions. The stock market serves an important purpose in a market economy by helping the economy grow and operate efficiently.

About a Market Economy

A market economy might have some government intervention, such as the regulation of certain industries, but supply of and demand for products and services generally drive most business decisions. Supply is the products and services offered by companies and demand is consumers’ willingness to purchase them. For example, if a clothing manufacturer determines that consumers demand a certain type of shirt, it will manufacture those shirts to sell to consumers. The government would have little, if any, involvement in this process.

Provides Company Funding

Companies often need large amounts of capital to generate enough production capacity to meet consumer demand in a market economy. The stock market allows companies to raise money from private investors that might not be available through bank loans or other sources. For example, if a company needs $100 million to build new manufacturing facilities and a distribution network, it can raise $100 million by selling stock to investors.

Creates Wealth

While companies benefit from the capital that investors provide through the stock market, investors can benefit by participating in a company’s success. Shares of stock represent ownership in a company and give investors a stake in a company’s future profits. Stocks are an important investment vehicle that individuals, pension funds and other investors use to grow wealth. For example, if you buy stock in a company that experiences growth, its stock price will likely increase, which increases your wealth.

Facilitates Information

The stock market provides key information that businesses and individuals use to make financial decisions. Public companies provide transparent information about their businesses, and stock prices can help indicate economic strengths and weaknesses. For example, an electronics business considering expansion can research public electronics companies’ financial reports and stock prices to help determine the industry’s future potential. Rising company revenues and stock prices might suggest growing consumer demand in the electronics industry.

About the Author

Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.

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