Major Economic Theories – When I first dipped my toes into investing, I had zero idea how much economic theory would shape the decisions I’d be making. I figured if I just watched some YouTube videos, bought a couple of stocks, and hoped for the best, I’d be rolling in profits soon enough. Spoiler alert: it didn’t work out quite like that. It wasn’t until I started digging deeper into some core economic theories that I truly began to understand the underlying forces driving markets.
So, if you’re an investor—or even just someone considering diving in—it’s critical to get a handle on some of the major economic ideas that can help steer your decisions. Some of these concepts might sound intimidating at first, but trust me, once you start applying them, they can really sharpen your instincts. Here are five key economic theories every investor should get familiar with:
Major Economic Theories Every Investor Should Know
1. Supply and Demand: The Foundation of Everything
I’ve learned the hard way that if you don’t get supply and demand, you’re bound to make some really rookie mistakes. This theory is basically the heartbeat of the economy. It’s simple: when demand for a product or asset increases, but the supply stays the same, prices go up. Conversely, when supply increases but demand stays stagnant (or falls), prices drop.
Let me give you an example. Back in 2020, when the world was in lockdown, everyone and their dog was suddenly investing in tech stocks. Apple, Amazon, Microsoft—you name it, they soared. Why? Well, demand shot through the roof as people turned to these companies for their work-from-home needs, entertainment, and shopping. The supply of shares didn’t change much, so the price per share just kept climbing.
But then, when the economy started to reopen, the demand slowed down (not as many people were stuck at home). That’s when we saw some of those tech stocks take a bit of a tumble. If you can understand how supply and demand drive these movements, you’ll start making smarter choices about when to buy and sell.
2. The Efficient Market Hypothesis (EMH): Don’t Waste Your Time Trying to Outguess the Market
The Efficient Market Hypothesis was one of those ideas that I really struggled to wrap my head around in the beginning. The theory suggests that all available information is already reflected in asset prices. This means it’s nearly impossible to “beat” the market consistently, because if something is publicly known, it’s already baked into the price.
For example, think about a company’s quarterly earnings report. If the report is great, everyone knows it, and the stock price jumps accordingly. But if you’re trying to predict what’s going to happen next based on some inside info or a hunch, you might be wasting your time. The market’s already priced that in.
This doesn’t mean you can’t make money—far from it. It just means you shouldn’t assume that you can consistently outsmart the market by trying to predict short-term price movements. Focus on long-term investing, diversify, and don’t stress about trying to time the market perfectly.
3. Behavioral Economics: The Psychology of Investing
Now, this one was a game-changer for me. Behavioral economics explores how psychological factors, emotions, and biases impact the way we make financial decisions. Trust me, when I first started, I was riding high on optimism, making reckless decisions based on gut feelings or fear of missing out (FOMO).
One thing I learned the hard way? Anchoring. This is when you make investment decisions based on irrelevant information, like the price you paid for a stock in the past. I remember buying some shares of a company years ago when the stock price was much lower. As the stock went up, I kept thinking, “It’ll get back to that level. I’ll hold on.” Spoiler: it didn’t. I missed my opportunity to sell at a decent profit simply because I was anchored to that past price.
If you’re an investor, be mindful of biases like this. Acknowledge that your emotions will likely play a role in how you react to market events, but don’t let them dictate your decisions. Understanding behavioral economics helps you keep your cool when the market throws you a curveball.
4. Keynesian Economics: Understanding Government’s Role in the Market
Keynesian economics is based on the work of economist John Maynard Keynes, and it focuses on how government spending can help stabilize the economy. When the economy is in a slump, Keynesians argue that the government should spend money to stimulate demand, even if it means running a deficit.
I can remember looking at the economic recovery plans during the COVID-19 crisis, and the immediate government stimulus packages that were rolled out. The idea was that by pumping money into the economy, people would start spending again, which would drive growth and pull the economy out of its recession.
Now, I’m not suggesting you should just rely on government action to solve all problems, but knowing how these policies affect the market is crucial for your investing strategy. If you can spot when the government is likely to intervene (say, with infrastructure projects or stimulus checks), you can anticipate trends in certain sectors—like construction or consumer spending—that benefit from this type of spending.
5. Monetarism: Money Supply Matters More Than You Think
Monetarism is one of those theories I used to think was too complicated, but it’s actually a big part of what shapes the market. In simple terms, monetarists believe that the money supply in the economy is a key driver of inflation and economic growth. If there’s too much money floating around, you’ll get inflation. If there’s too little, economic activity slows down.
This theory became super relevant to me when I started following the Federal Reserve’s actions more closely. Whenever the Fed raises or lowers interest rates, it’s typically trying to control inflation by manipulating the money supply. If interest rates are low, borrowing becomes cheaper, which means more money is circulating. If rates are high, borrowing slows down, and money supply shrinks.
Paying attention to the Fed’s moves can give you insights into the broader market, especially if you’re looking at things like bond yields or inflation-protected assets.
Final Thoughts Honestly, I can’t say enough how much understanding these economic theories has changed my approach to investing. They’re like a secret code for reading the market. If you ignore them, you might end up reacting to market shifts like a headless chicken, buying high and selling low. But if you dig into these theories, get comfortable with the concepts, and apply them to your investments, you’ll start making decisions that are more calculated and less emotional.
So, whether you’re just getting started or you’ve been in the game for a while, I highly recommend you take the time to study these five major economic theories. They’ll not only help you avoid making costly mistakes, but also give you a clearer sense of how the world of investing really works
