Question

4. In the Baumol-Tobin model, show that the optimal solution entails equality between the foregone interest costs and total brokerage costs. (Use the fact that in the model, n, the number of times you sell bonds per period, is equal to PY/2M, where PY is money income and M is average money demand

Answer 1

AMgwers In Baumol Tobin modl, e optinal Solutian entails Equality betwean the faregone interet Costs and ttal bokage :Foaud)o GnSidaring tegiven problem, here N-humber of-time you sell bonds F-bokerage fe Linret Tate = orrortunity Cott of holding money. Jmoney in come 1 in Come holdy/2N average So the fore gone mteret Yate i8 given by Yi2N and the gimn by F' blookerage cot So total cost functian is gjven by, TC Y2N +FN dre/dN Focrequied

Ciy aNF = iy /NF iylaF-N 0.5 Ny/F be the optinun valve of N Sofareg one interet Cast is gien by yN=iy/2 (I iy/2) Woua esokerage cast is gien y PN -Fy2F) CTYFLS foregane interetCalt 80/ at-k optmamfregane intretcais Same obokeroge ctt