Economics • Economic BasicsHard
What is the primary implication of 'Baumol-Tobin Model' of cash management?
A. Money demand for transactions is completely unresponsive to interest rates.
B. The demand for money holdings for transactions exhibits economies of scale with respect to income and varies inversely with the interest rate.✓ Correct Answer
C. Precautionary demand for money is solely determined by psychological factors.
D. Inflation expectations are the only driver of currency substitution.
💡 Solution & Explanation
The Baumol-Tobin model applies inventory theory to money demand, demonstrating that transaction demand for cash exhibits economies of scale with respect to income and varies inversely with the nominal interest rate. Alternative choices suggesting complete unresponsiveness or focusing solely on psychological factors contradict this inventory-theoretic framework.
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