Summary of Key Concepts of Economics - Essay Example

1. Summary of Key Concepts The concepts of demand and supply are critical in many aspects of trading, especially in share prices and dividend yields.An analysis of the factors that determine share price can be grouped in two broad classes, supply and demand, each of which can be divided into several areas. The prices of shares in all quoted companies are determined by the demand and supply of the shares. In this case, the stock of a company can be sold in a primary or secondary market, where the primary stock exchange refers to the sale of new shares issued and the secondary market refers to the trading of existing shares. When a firm releases stock for trading, the shares are sold in the primary market, and when the shares are traded according to changes in prices, they are traded in the secondary stock market. The main area of discussion is secondary stock markets, where the share prices fluctuate depending on the demand and supply of the shares. This means that share prices are affected by demand and supply of the shares in the market. The first factor that influences the demand for shares is the dividend yield of the shares (Sloman, Hinde & Garratt, 2010). When shares are issued, investors expect to earn a return on the shares they buy. This return is referred to as a dividend, which a return paid on every share held in a firm. The investors expect to earn a good return on the shares they hold in a firm, and when the dividend yield is high, the demand for the shares will rice, which will in turn increase the price of that firm’s shares. The second factor that affects the demand for shares is the price and accompanying return for substitutes. In this case, if the substitute of a share is expected to offer a higher return, the substitute will reduce the demand for the first share, which will reduce the share price. The main substitute for a class of shares is usually rival firms’ shares, property and savings or risk free investment options. The third factor that affects the demand for shares is the income of the investors. The disposable income that an investor has is dependent on the income; therefore, more disposable income increases the money available for investment, which in turn increases share price. Apart from disposable income, share demand is also affected by the wealth of the investors, which refers to accumulated savings and property. Increasing wealth will increase the amount of investment available for share buying, which in turn increases share demand and price. The last factor that affects the demand for shares is expectations about the share price, where expected increases in share prices raises expectations for profit, therefore, the demand for shares is expected to rise. The second factor that influences share price is the supply for shares, where the factors are exactly opposite to the factors that affect demand for shares. For example, a low dividend yield for shares mean that the people holding the shares will release more shares, which swamps the market for shares and reduces the share price. Falling prices for substitutes increases the prospects of a firm’s shares, therefore, the owners will hold on to the shares and the prices will rise due to low supply. 2. Questions Question 1 If the economic growth for an economy is 3% for a particular year, share prices are expected to rise by more than 3% in that year because of the expectations of the shareholders. As already explained, the expectations that investors have are dependent on the state of the economy, and if the economy is expected to be favorable, then investors are expected to demand more shares. In this case, the accompanying demand for shares will raise the share prices for many firms. This is also accompanied by the supply of the shares, where the owners of the shares are reluctant to sell because of the rising expectations. The owners also foresee an increase in investment; therefore, they are reluctant to release their shares. This will reduce the supply for shares, which will in turn increase the share price. Question 2 An analysis of the FTSE 100 index for the last one year indicates numerous ups and downs, which can be explained by the share price demand and supply. The index closed at a value of 5917.71 on January 25, 2011, and closed at 5782.56 on January 23, 2012 (Bloomberg, 2012). The index had a low of 4944.44 on April 10, 2011, and the highest value of 6091.33 on February 8, 2011. The fluctuations in the FTSE can be explained by the volumes of shares traded for the individual shares for the firms in the index, where the highs indicate a high volume of shares traded, and the lows indicate a low demand for shares due to low expectations. 3. Application The concept discussed in this paper can be used to explain the issues that appear in an article by Bowley, Hauser and Schwartz (2011). The article discusses the fall in holdings of Italian government bonds due to expectations that the shareholders held about the performance of the economy. Due to the recent Euro zone crisis, many investors have low expectations about the performance of European stocks and holdings, and as the article indicates, one of the fails was the Italian economy. According to Bowley, Hauser and Schwartz (2011), a global stock market sell-off for Italian stock was precipitated by an influx in dropping Italian government bonds. The concept of investor expectations can be used to explain this phenomenon, where investors hold shares according to expectations of future return. The Euro zone crisis prompted investors to lower their expectations of European stocks, thus the resulting drop in Italian stock holdings. The article tries to explain that the surge in Italian bond yields was precipitated by the dropping of Italian shares held, which is in agreement with the concepts discussed in this paper. The expectations by investors fell due to the Euro zone crisis, therefore, it is expected that the share price for Italian stocks will fall. References Bloomberg. 2012. FTSE 100 Index, Bloomberg, Viewed January 24, 2012, Bowley, G., and Hauser, C., and Schwartz, N. 2011. Fear of Contagion Rocks Markets, New York Times, Viewed January 24, 2012, . Sloman, J, Hinde, K & Garratt, D. 2010. Economics for Business, Pearson Ed. United Kingdom. Read More