The Baumol-Tobin square-root formula predicts that the amount of money balances held should

Question

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The Baumol-Tobin square-root formula states that the optimal amount of money balances to hold depends on the cost of conducting transactions, the interest rate, and the level of income. As the cost of conducting transactions increases, it becomes more expensive to hold money balances, so people will want to hold fewer of them. As the interest rate increases, the opportunity cost of holding money balances (i.e., the forgone interest) increases, so people will want to hold fewer of them. Thus, money balances will move in the opposite direction from the interest rate, which corresponds to choice A. Additionally, as the level of income increases, people will have more funds available to hold in money balances, so the amount held will increase, but this increase will be less than proportional to the increase in income, which corresponds to choice D. Therefore, the best choice is E, as both A and D are correct.

The Baumol-Tobin Square-Root Formula Predicts That the Amount of Money