Tobin q basic idea

Basic Idea:

Rate of investment in any type of capital can be predicted
by looking at the ratio of the capital’s market value to the
replacement cost of its capital stock.
When the ratio of capital market value to its replacement
Notescost (Tobin’s q) is > 1, it is profitable for the firm to acquire
additional capital because the value of capital exceeds the
cost of acquiring it; and vice versa. Investment is therefore a
positive function of the q ratio.

Since much of the value of firms come from the capital they
own, the stock market value of a firm can be used as a
measure of the market value of the firm’s capital stock.

If the replacement cost of capital isn’t changing much
then a boom in the stock market (an increase in V) will
cause Tobin’s q to rise for most firms increase in the
rates of investment. Simply put, when the stock market is
high, firms find it profitable to expand.