Reading based questions

a. The Economist – Tobin’s q article

i. Why does a 𝑞 > 1 mean that companies should increase their investment?
The average Tobin’s q theory includes the following ratios:
𝑇ℎ𝑒 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑙𝑎𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑠𝑠𝑒𝑡
𝑞=
𝑟𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
According to the reading, it is observable that if q>1 the assets are being overpriced in the
stock market or it is valued higher than it actual cost. The investors see this as an
arbitrage opportunity and recognize it as an incentive to invest to book more profits. The
investors invest until q becomes equal to 1. The returns from the assets bought at q>1 will
be higher.
ii. How does Tobin’s 𝑞 treat intangible assets and goodwill?
Tobin q does not take into account the intangible assets and goodwill. It is because they
are not recognized it calculating the total value of assets for Tobin’s q. Hence, economist
argues that it cannot determine the actual cost of the assets. The exclusion of intangible
assets and goodwill results in an overstated ratio of Tobin’s q.
b. The Economist – multipliers article
i. What are some of the reasons which make the multiplier a variable rather than a
constant value over time?
There are many different economic conditions which makes a multiplier a variable rather
than a constant value over time. In a case scenario of a recession or any economic period
where the factors are productions seems to be not fully employed, the increase in the
government spending will also increase the expenditures and demand of the
firms/consumers. Hence, multiplier will take a high value (can also be above 1).
Whereas, at full employment, the multiplier may have a close to zero value.
Moreover, it is also observable in the reading that changes government spending can
demonstrate a bigger effect on the multiplier than changes in taxes. And governmental
borrowing may also result in immediate fall of fiscal multiplier.
ii. Why will fiscal multipliers be lower in indebted economies?
In an indebted economy, we might observe a financial crisis as a large group of people
will be closer their credit limits. It will put a borrowing constraint; hence people will try
to cut their borrowings. It will result in a lower multiplier, as output will fall resulting in
the decrease/fall of fiscal multiplier.
c. The Economist – home truths
i. How does the “wealth effect” in this article relate to our PIH and intertemporal
utility maximization framework? Does our framework predict this?
In the PIH an intertemporal utility maximization framework, consumers will react to
permanent changes in income. In easier word, consumer’s current consumption decisions
will depend on the consumer’s future income levels. For example, as the article mentions
that an increase in the house prices by $100 will result in the increase in the people
wealth and their spending i.e., by $9. The “wealth effect” shares the same ideas. If
 consumer’s asset value increases in the future, then the consumer will feel safer to spend
more on consumption. And vice versa if asset value decrease in the future.
ii. Why do you think housing wealth has had a bigger effect on consumption than
financial assets?
Housing wealth have a bigger impact on consumption as compared to financial assets
because housing wealth is more convenient as people may use it to pay or take out loans,
replace mortgages with new mortgages, and rent out property for monthly income. Since
property rates tends to only grow in time except when there is a recession, people also
sell out their homes after a couple of years to book profits. Whereas financial assets
volatile as compared to property asset and they rise less in the long run as compared to
real estate assets. Hence, when property asset value grow overtime, the wealth effect
kicks in and people start to increase their consumption.