(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 209

184 PART 2 • Producers, Consumers, and Competitive Markets

7

50
45

6

Dividend Yield
40

P/E Ratio

30

4

25
3

20
15

2

Dividend Yield (percent)

5

35

10
1
5
0
1970

P/E Ratio
1974

1978

1982

1986

1990 1994
Year

1998

2002

2006

2010

0

F IGURE 5.9

DIVIDEND YIELD AND P/E RATIO FOR S&P 500
The dividend yield for the S&P 500 (the annual dividend divided by the stock price) has fallen
dramatically, while the price/earnings ratio (the stock price divided by the annual earningsper-share) rose from 1980 to 2002 and then dropped.

1970 to 2011. Observe that the dividend yield
(the annual dividend divided by the stock price)
fell from about 5 percent in 1980 to below 2 percent by 2000. Meanwhile, however, the price/
earnings ratio (the share price divided by annual
earnings per share) increased from about 8 in
1980 to over 40 in 2002, before falling to around
20 between 2005 and 2007 and then increasing
through 2011. In retrospect, the increase in the
P/E ratio could only have occurred if investors
believed that corporate profits would continue
to grow rapidly in the coming decade. This suggests that in the late 1990s, many investors had a
low degree of risk aversion, were quite optimistic
about the economy, or both. Alternatively, some
economists have argued that the run-up of stock

19

prices during the 1990s was the result of “herd
behavior,” in which investors rushed to get into
the market after hearing of the successful experiences of others.19
The psychological motivations that explain herd
behavior can help to explain stock market bubbles.
However, they go far beyond the stock market.
They also apply to the behavior of consumers and
firm managers in a wide variety of settings. Such

behavior cannot always be captured by the simplified assumptions that we have made up to this point
about consumer choice. In the next section, we will
discuss these aspects of behavior in detail, and we
will see how the traditional models of Chapters 3
and 4 can be expanded to help us understand this
behavior.

See, for example, Robert Shiller, Irrational Exuberance, Princeton University Press, 2000.