Question

In the Baumol-Tobin model, an increase in transaction costs reduces the number of times individuals exchange interest-bearing assets and money, thus lowering the demand for money, true or false with explanations.

Answer 1

According to Baumol-Tobin model, if the transaction costs is denoted as C, the income receipt of the individual is Y, interest rate is denoted as i, then the demand for money is

(M/P)d = L =

Here, we are told that, the transaction costs has increased. But the interest rate (i) and income receipt (Y) are fixed.

From the above formula of demand for money, we can see that, if Y and i are same, then money demand (L) increases if C increases and money demand decreases if C decreases.

Here, C has increased. Hence, demand for money increases.

But according to the statement, it says that demand for money is lowered. Hence, this statement is false.

Answer: The statement is FALSE.

Hope the explanation is clear to you my friend.