Is stock investment an example of demand curves that slope upwards?

Question

The law of demand implies that when the price of a good rises, people buy less of it. This makes the demand curve slope monotonically downwards. A textbook exception is the so-called Giffen good that by definition behaves in the opposite way.

But take a stock on the rise; might there not at least be one tendency for people to buy more of it under some circumstances, because it looks promising, in spite of any opposite tendencies? Is or isn't this another case where a demand curve may slope upwards?

Answer 1

The observation that "as stock prices rise people tend to buy more of it, so here the "law of demand" holds in reverse", is one of the more widespread misconceptions related to economic thinking.

To expand on @StevenLandsburg comment, the "demand curve" (or "schedule") describes a static relation between the quantity of a good and its price. Its quality (in the general sense of features, qualities) remains constant, as we trace the demand curve.

In our case we think of the stock as the good, and we have also its price. Now what happens when the price goes up? Are we talking about the same good? Definitely no. The price raise itself signals that we now have a better good (higher discounted future profits). But then we have a different good. So the pairs $(p_1, q_1)$ and $(p_2, q_2)$ do not really belong to the same demand schedule. So the "law of demand" is irrelevant here as a tool to describe the situation (we could picture it as a shift of the whole demand schedule outwards)

If one wants to try to think "intuitively" about the law of demand and stocks, then one can consider the following thought experiment:
Assume that you can buy the same stock on the same day at two different prices (it can happen, the world is not really one single market, even for stocks -and transactions can happen also outside of the stock market).
Assume that you cannot choose the seller, which will be determined randomly. But you have to commit beforehand about the number of pieces that you will buy. And you know the two prices.

What are you going to do? Commit to buy more pieces if you are dealt the expensive seller, and fewer pieces if you are dealt the cheaper seller? Sounds ridiculously obvious, isn't it?

Answer 2

There are two completely separate reasons why you shouldn't think of stocks as Giffen goods. Alecos has very nicely explained the first reason.

The other is that consumer theory --- maximization subject to a budget constraint --- does not apply to financial assets, because here there is in principle no budget constraint. That is, there's a limit to how much you can borrow for a trip to Hawaii, but there's no limit in principle to how much you can borrow to buy assets that throw off income.

Note that the whole theory of Giffen goods --- the Slutsky equation, etc. --- relies on the budget constraint. That's exactly why there are no Giffen factors of production, even in theory.

So Alecos's point is that to call a stock a "Giffen good", you'd have to demonstrate an upward sloping demand curve holding quality constant. The point here is that to make sense of a stock as a "Giffen good" you've got to have a budget constraint. So even if you ignore Alecos's point entirely, there is still no chance for a financial asset to be a Giffen good.

Answer 3

I would note that the value of a stock is highly speculative and prone to herding effects.

Let's say today the stock of company X is worth $100 dollars, but the price is subject to fluctuation by chance, investor decisions, and real improvements in company X.

When the stock price of company X goes up to \$101 tomorrow, an uninformed investor may reason that informed investors know something about real improvements in company X and have bought into it, driving the price up.

As a result, the rational, but uninformed investor also buys company X. This behavior persists even if the price increased by random chance because it is possible that the price increase is legitimately due to improvements in the company.

A critical thing about this is that the investment good is not the same on each day. In the first period it is a "good with no known information". In the second period it is a "good and a positive signal". You are paying extra for the attached signal, whether or not the signal is accurate.