Which of the following is true of the Baumol model?Note that the optimal cash transfer amount is C*.
A) if the total amount of cash needed during the year increases by 20%, then c* will increase by 20%.
B) if the average cash balance increases by 20%, then the total holding costs will increase by 20%.
C) if the average cash balance increases by 20% the total transactions costs will increase by 20%.
D) the optimal transfer amount is the same for all companies.
E) if the fixed costs of selling securities or obtaining a loan (cost per transaction) increase by 20%, then c* will increase by 20%.

Question

Quizplus · Accepted Answer

The Baumol model states that the optimal cash transfer amount is determined by the trade-off between holding costs and transaction costs. If the average cash balance increases by 20%, then the holding costs will increase by 20% because more cash needs to be held on hand, but the optimal transfer amount (C*) will not necessarily increase by the same amount. Therefore, option B is true. Option A is incorrect because an increase in the total amount of cash needed during the year does not necessarily mean that the optimal transfer amount will increase by the same percentage. Option C is incorrect because an increase in the average cash balance would actually decrease the total transactions costs due to fewer transfers needed. Option D is incorrect because the optimal transfer amount will differ for each company based on their unique cash management needs. Option E is incorrect because an increase in transaction costs would actually lead to a decrease in the optimal transfer amount to minimize those costs.

Which of the Following Is True of the Baumol Model?Note