Recitation_4_F09

# Recitation_4_F09 - 1 14.02 Recitation 4 Baumol-Tobin Model...

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1 14.02. Recitation 4. Baumol-Tobin Model of Money Demand In class we saw that money demand takes the form M d = PL d ( Y;i ) where L d is increasing in real income Y and decreasing the nominal interest rate i . But: where does this L d come from? Today we will see an example of a theory that gives us the L d function. Why do people choose to hold money if they can leave their wealth in the bank and get some return on it? Cost of holding cash: the forgone interest you would have perceived had you left the money in the bank. 1.1 The Baumol Tobin Model Consider an individual who needs to spend Y dollars gradually over the course of a year. He has Y dollars deposited in a bank account, and can make as many trips as he wants to the bank to withdraw money from this account. He needs the money to make transactions (buy things). One the one hand, each trip to the bank is costly, and this leads a motive to withdraw as much as possible in each trip. Suppose each trip has

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Recitation_4_F09 - 1 14.02 Recitation 4 Baumol-Tobin Model...

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