The rate of interest, r, is fixedand known.4.
The cost of switching frombills/bonds to money is a fixedamount, b[what Baumol calls
“the brokerage fee”] reflecting
both subjective and objectivecosts.5.
Individual always transfers thesame quantity of money out of bills each time, K, running thisholding down to zero beforemaking his next withdrawal.i.e., K is the size of each cashwithdrawal at intervals whenbonds are sold.
is the amount of withdrawals that occur overthe year [particular period]There are two types of cost incurredby the market operator.i.
The brokerage charge, which is
, i.e., the brokerage fee times the number of transfers made; andii.
The income foregone by holding money-since expenditure is assumed to be aconstant flow, so that actual money balances are run down evenly over the holdingperiod, the average money balance must be
. The cost is therefore this averageholding times the rate of interest foregone,
.Since transactions are directly proportional to time, the pattern of money holdingover time can be related to the income-expenditure pattern.[In other words, Baumol
takes into account an individual’s demand for money. Suppose‘T’ indicates the transactor’s real income. ‘K’ is the real value of the bonds that thetransactor encashes frequently, ‘b’ is the brokerage for transforming bonds
and vice versa. The transactor’s real income is given at the beginning of the month and
it gets fully spent up to the end of the month. Now the transactor will try to minimizethis cost of turning bonds into money. The transactor gets income as a lump sum only
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