Econ402_Set6

# Econ402_Set6 - PS 6 Two Canonical Models(60 raw points ECON...

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PS 6 – Two Canonical Models (60 raw points) ECON 402, Prof. Bachmann Due: March 10 Explain all your answers. “Results only” means partial credit only. Staple and write legibly. No spiral stuff. Write on the top of the front page of the assignment you hand in: name, section number, section time and section GSI. The numbers in brackets are the subdivision of raw points for each question. I) The Baumol-Tobin Inventory Model of Money (Cash) Demand (30 raw points) Sarah – your old high school friend – now works for a living and receives a paycheck of \$Y dollars per month (notice that here Y denotes nominal income for the sake of notational simplicity, whereas usually it denotes real income). Sarah is paid at midnight on the last day of the month, with a direct deposit into her interest bearing bank account. She spends all \$Y during the month, so at the end of the month she has exactly zero dollars in her account. The account pays - at the end of the month - a nominal interest rate of R on the AVERAGE cash holdings per month, L . Only cash is accepted for transactions, so Sarah needs to walk to an ATM and pay a fixed cost \$F per trip to get cash. Sarah wants to economize on trips, by

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