667 $
© 2014 Pearson Canada Inc.$- In the Baumol-Tobin model, given that total costs for an individual equals + , where
= monthly income, b = brokerage costs, and C = amount raised from each bond transaction,derive the so-called square root rule.
Answer: An individual will minimize their costs Thus, the optimal level of C is found as
follows:
COSTS = +
= + = 0
=
Since money demand is the average desired holdings of cash balances, C/2:
= =
The last expression is the square root rule
Diff: 2 Type: SA Page Ref: 21.A- 4
Skill: Recall
Objective List: Appendix: A Mathematical Treatment of the Baumol-Tobin and Tobin Mean-
Variance Models