Function

• The stock market provides a means through which companies can raise investment capital. By selling shares of ownership, companies have a source of capital from investors, who in turn become part owners of the company. Owners of stock then have the opportunity to see the value of their shares increase over time as the company's profits generate value for stockholders.
  
  

Significance

• Changes in stock prices often reflect economic conditions. The large drop in the Dow Jones Industrial Average in 2008, for example, reflected investors' fears of a widening recession becoming a global financial meltdown. News of large declines in stock prices may discourage consumer spending, a significant portion of gross domestic product. Rising stock prices may fuel additional consumer spending, as investors see their wealth increase.
  
  

Effects

• The Economics Help website outlines ways in which the stock market affects economic activity. First, the market creates a wealth effect, in which changes in stock prices increase or decrease investors' wealth. The site points out, however, that the wealth effect may be small, as many people who buy stocks do so knowing they can lose money. In addition, anyone with a pension or 401k will be affected by changes in the stock market, as pension funds invest part of their holdings in the stock market. Changes in stock prices also affect the ability of publicly traded companies to raise capital.
  
  

Expert Insight

• World Bank economist Ross Levine writes in a paper for a World Bank conference that stock markets, especially in developing nations, can provide a boost to those countries' economic development efforts. They affect development by creating liquidity, which makes investment more attractive because it enables investors to acquire an asset that they can sell quickly if they need access to their money.
  
  

Warning

• The Economics Help website points out that a declining market alone does not necessarily foretell a decline in economic activity. The 2008 decline in global stock markets reflected economic weaknesses, but the 1987 crash did not result from any obvious economic problems.