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Select Topics in Macroeconomics – 2014
Questions and Answers
Section A
Question 1
Tobin’s q ratio is a measure of firm assets in relation to a firm's market value. The formula for this
measure is:
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 = 𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 / 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 (𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡)
When the Tobin's Q ratio is between 0 and 1, it costs more to replace a firm's assets than the firm is
worth. A Tobin's Q above 1 means that the firm is worth more than the cost of its assets. A firm
should therefore invest if their q is greater than 1. This is because the profits generated would
exceed the cost of the firm’s assets. If q is less than 1, it implies that the firm would be better off
selling its assets instead of trying to put them to use. The ideal state is where q is approximately
equal to one denoting that the firm is in equilibrium.
Tobin’s q can be measured empirically by the following formula:
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 = (𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 + 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒) /(𝐸𝑞𝑢𝑖𝑡𝑦 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒
+ 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒)
A possible shortcoming of using Tobin’s Q ratio as a tool for valuing companies, or for determining
whether a firm should invest, is that the replacement value may not be clear. For physical capital,
such as bricks and mortar, there are markets which determined the equilibrium prices for these
goods. However, goods or services which are unique to the company may not have typical market
prices (e.g. complicated bespoke software). Therefore, the current prices of these unique assets
cannot be robustly estimated, and therefore it is difficult to obtain an objective estimate of the
replacement value.
Question 2
The monetary policy makes wishes to minimize social welfare loss, which can be expressed as:
𝐿 = 0.5 𝑎 (𝜋 − 𝜋 ∗) + 0.5 (𝑦 − 𝑦 ∗)
Where π is the inflation rate, π ∗ is the socially optimal level of inflation, y is the level of output, and
y* is the social optimal output. The economy can be described by the aggregate supply equation:
y = y + b(π − π )
ECONOMICS HELP, visit LondonEconomicsTutors.co.uk.
Discounted prices compared to all other websites
Select Topics in Macroeconomics – 2014
Questions and Answers
Section A
Question 1
Tobin’s q ratio is a measure of firm assets in relation to a firm's market value. The formula for this
measure is:
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 = 𝑇𝑜𝑡𝑎𝑙 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 / 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑖𝑟𝑚 (𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡)
When the Tobin's Q ratio is between 0 and 1, it costs more to replace a firm's assets than the firm is
worth. A Tobin's Q above 1 means that the firm is worth more than the cost of its assets. A firm
should therefore invest if their q is greater than 1. This is because the profits generated would
exceed the cost of the firm’s assets. If q is less than 1, it implies that the firm would be better off
selling its assets instead of trying to put them to use. The ideal state is where q is approximately
equal to one denoting that the firm is in equilibrium.
Tobin’s q can be measured empirically by the following formula:
𝑇𝑜𝑏𝑖𝑛′𝑠 𝑄 = (𝐸𝑞𝑢𝑖𝑡𝑦 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒 + 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑀𝑎𝑟𝑘𝑒𝑡 𝑉𝑎𝑙𝑢𝑒) /(𝐸𝑞𝑢𝑖𝑡𝑦 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒
+ 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒)
A possible shortcoming of using Tobin’s Q ratio as a tool for valuing companies, or for determining
whether a firm should invest, is that the replacement value may not be clear. For physical capital,
such as bricks and mortar, there are markets which determined the equilibrium prices for these
goods. However, goods or services which are unique to the company may not have typical market
prices (e.g. complicated bespoke software). Therefore, the current prices of these unique assets
cannot be robustly estimated, and therefore it is difficult to obtain an objective estimate of the
replacement value.
Question 2
The monetary policy makes wishes to minimize social welfare loss, which can be expressed as:
𝐿 = 0.5 𝑎 (𝜋 − 𝜋 ∗) + 0.5 (𝑦 − 𝑦 ∗)
Where π is the inflation rate, π ∗ is the socially optimal level of inflation, y is the level of output, and
y* is the social optimal output. The economy can be described by the aggregate supply equation:
y = y + b(π − π )
