Question

According to the Baumol–Tobin model, what determines how often people go to the bank? What does this decision have to do with money demand?

Answer 1

Baumol–Tobin model makes an assumption that there are two types of assets, money and bonds. Money does not pay interest but the Bonds pay; thus households make a decision on how much of their wealth to hold in bonds and money. The household can make use of only noninterest-bearing money for their purchases. Thus when they have money demand the household can draw money from their savings/brokerage account. But this conversion is not for free as involves time the expense associated with withdrawing funds and going to a bank, or any fixed expenses that must be paid to brokers. As the rate of spending of household’s on commodities is constant throughout the month, thus they visit the bank at regular intervals and withdraw the same money amount. The equation used is: