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Tobins Model
Tobins Model
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schedulingwill be the one which gives the great- Chart i presents two possible ways of schedul-
est interest earnings. ing two transactions. The first way, shown in
If there is one transaction, from cash into Chart ia, is to hold all cash, no bonds, until
bonds, there must be at least a second transac- time t1; to buy B1 bonds at that time; to hold
tion, from bonds back into cash. Bonds cannot these, and earn interest on them, until time t2;
be used for payments, and the entire initial and then to convert them into cash. Total in-
transactions balance must be paid out by the terest earnings are proportional to the shaded
end of the period. area. The second way, shown in Chart ib, is
In Chart i, the total transactions balance T to buy the same amount of bonds B1 immedi-
is plotted against time, as in equation (i). ately on receipt of periodic income Y, and to
For n = 3, the solution is illustrated in Chart becomes indefinitely large. Marginal revenue,
4, which may be compared with Chart 3. In R.n+j -Rn, is a positive decreasing function of
Chart 4 it is assumed that 2b/r = Y2, i.e., that n, which approacheszero as n becomes infinite:
the size of transaction cost per dollar is Y4 of 2
the interest rate. The effective beginning time I _2b
Rn
is thus t1 = ?2, and the effective beginning bal- -RYr2n(n+I) II r
ance is T(Y2) or Y/2. (n :-2),
(r :-2b) (I
Total cost, na, is simply proportionalto a; and
CHART 4. - SCHEDULING OF TRANSACTIONS marginalcost is a constant.
(Transaction cost per dollar equal to one-fourth There are four possible kinds of solution n *,
interest rate) of which Chart 5 illustrates only one. These are
I
defined by the relation of the interest rate to
volume and costs of transactions, as follows:
APPENDIX
I. Suppose that (I - t2)Y bonds are bought at as the initial purchase, (I - t2) Y, total transaction
time t = o and held until t = t2. From t2 until t3, costs - ignoring those costs, na, which are fixed
(I - t3)Y bonds are held. In general, from t1-1 when the number of transactions is fixed - are
until ti, (i - ti) Y bonds are held, and finally from 2b (i- t2) Y. Consequently, revenue Rn is given by
t.-1 until t., (i - tn) Y bonds are held. After t1,n the following expression:
bond holdings are zero. Every dollar of bonds held
Rn = Y* t2r+(I I-t3) ' (t-t2)r+ ...
from ti-. until ti earns interest in amount (t - (II-t2 *h