Question

This is all I got given.

2. Let's try to apply the Baumol-Tobin model to your day to day life. a. How much do you buy per year with currency (as opposed to checks or credit cards)? This is your value of Y. b. How long does it take you to go to the bank and get cash out? What is your hourly wage? Use these two figures to compute your value of F, or try to estimate your total transaction cost the best you can using other methods. c. What interest rate do you earn on the money you leave in your bank account? d. According to the Baumol-Tobin model, how many times should you go to the bank each year, and how much should you withdraw each time? e. In practice, how often do you go to the bank, and how much do you withdraw? f. Compare the predictions of the Baumol-Tobin model to your behavior (think about your cash spending behavior here). Does the model describe how you actually behave? If not, why not? How would you change the model to make it a better description of your behavior?

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Answer 1

The answer to this question is very subjective. However, certain insights into the Boumol -Tobin model will help us answer our questions in a better way.

Baumol-Tobin's model modified Keynes treatment of demand for money. In this model of cash management the costs and benefits of holding money are explained. Keynes treated transactional demand for money as the function of income only. However, Boumol-Tobin model explained how it is the function of income as well as the rate of interest.

Baumol-Tobin model shows that demand for money is positively related to the income level and negatively related to the interest rate. This model also lays emphasis on the explanation of assets. An individual holds portfolio for monetary assets (currency and checking account) and non-monetary assets (stocks and bonds).

This initial information will help us answering the given questions:

a. Let us assume that your annual income is 2 lakh dollars out of which you prefer to use $50000 as cash for transactional purposes.Thus, our Y=$50000. (Boumol Tobin model is only concerned with our transactional demand for money).

b. In Baumol-Tobin model, F is our cost of transferring non-monetary assets into monetary assets. In other words, it is the cost of going to a bank or brokerage fees. Let us say it takes 1 hour for you to go to a bank from your home to withdraw money and during this time, you are sacrificing one hour of your work time.if your wage rate per hour is say $15, then the transactional cost is $15 (equal to the value of work time sacrificed).

c. This value is easy to ascertain. it is the amount of interest your bank is giving you for leaving your money in the bank account.

d. According to the Baumol-Tobin model, the cost of holding money is minimum when the number of bank trips (N) is equal to:

N= $\sqrt{Yi/2F}$

where, Y= Transactioanal demand for money,

F= cost of going to a bank,

i= interest rate our bank is giving us for keeping money in the bank account..

Also,our average money holding should be: ($Y\div 2N$)