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How Does The Economy Affect The Stock Market - and Why

written by: Zaid Aysen•edited by: Doreen Martel•updated: 2/22/2011

The issuance of shares is a great way for companies to boost capital. Companies then use this additional finance for expansion and large scale expenditure projects. In this article we will examine how does the stock market affect the economy and why.

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    Fluctuating share prices have an indirect yet almost inevitable affect on the consumer at ground level. Certain share prices (such as those of oil and resource commodity holding entities) have a more dramatic impact on the economy as a whole than others. Share price fluctuations of small industry specific entities are more likely to have an effect on the market that their core business targets. Whatever the case share prices are the driving force in the survival, expansion or failure of businesses worldwide. Knowing how the economy affects the stock market and gaining some insight on share price fluctuation could benefit and add value to the financial decisions made by the stock trader, shop owner or average consumer.

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    Ways in Which Share Finance is Utilized by Companies

    How Does the Stock Exchange Affect the Economy and Why - The issuing of shares can be utilized depending on the economic needs of a company. In certain instances, it works out more financially prudent for a company to involve itself in long term financing. This could involve anything from a large asset purchase such as machinery and equipment to the construction of a complex or building. Company stability and future survival can be largely dependent on these fixed asset constraints. Finance for the purchase of these assets can be funded through the issuance of shares. Companies facilitate this type of financing by issuing bonds and stock via the stock exchange.

    Short term financing needs can also be met by the issuance of shares. However, this type of finance is usually utilized for the payment of company overheads and general operating costs. Short term debt investments are usually the chosen route for short term financing needs where short-term bonds, money markets and commercial papers are issued.

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    What Does the Stock Exchange Mean to the Economy

    A change in stock price can have a major impact on both investors and consumers. Investors, being direct participants in the unpredictable nature of the stock exchange, usually feel the benefit or brunt of any immediate change in the share price. However, if losses are occurring, it’s probable that a wave of reluctance for continuous investment spending on that company will probably set in. A reluctance or loss in confidence by investors can translate to a downturn in consumer spending in the long term. However, given the patient nature of many investors, a slight decrease in share price would not mean that much given their generally long term investment approach.

    Pension funds are to a large degree dependant on the stock exchange. A fall in a share price can have a significant impact on consumers’ pension payouts. Many marketing efforts by pension funds claim a stipulated return after a specified investment period. A continuous fall in share price may cause these claims to hold little weight and for investors returns to be hardly as profitable as what they initially envisaged.

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    Positive Affects of Stock Market Investment

    A company’s capital structure can be primarily funded by the issuance of shares. Shares allow for a comparatively cheaper means of raising finance so that the company can meet its financial objectives. Additional funding also allows the business to expand thereby contributing to the growth of the country’s Gross Domestic Product (GDP) and employment creation opportunities as well. As can be imagined, the more jobs available, the more per capita disposable income and the more stable the financial outlook of the people of the country. Sustained economic stability and growth can be maintained so long as this positive cycle of job creation and consumption continues.

    With the financing structure of the company now dependant on the funds of third party individuals and entities, the company becomes liable and accountable to its shareholders. Shareholders, however, would usually only choose companies that are well managed, profitable and with a positive and favorable future outlook. With caution and the need of producing results now evident from both the investor’s and the company’s point of view, good all round corporate governance is automatically promoted in practices such as bookkeeping and financial recording. This awareness of accountability in all organizations eventually filters through to the overall stability of the economy as a whole.

    The stock market is a tricky and sometimes volatile playing field. How the economy affects the stock market is a question that is on everybody's lips and minds after the reckless lending exploits of certain financial institutions that eventually led to the economic recession that occurred just before the turn of the decade. Businesses have become more prudent and more aware of economic volatility and disposable consumer income. The manner in which these factors influence business ,and ultimately, economic decisions remains to be seen.

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