The Inventory Theoretic Model of the Transactions Demand for Money

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Precautionary demand for money implies the stocking up of liquid money for use in times of exigencies. Lastly, transactions demand for money is that which the rational individual needs as a medium of exchange, to buy goods and services. The last component is the most important of all the three because people need money mainly for transaction purposes (Dornbusch &amp. Fischer, 2005). The demand for money to serve the other two purposes arise only at some particular points of time, viz., at times of exigencies or situations when the economy is at the edge of some emergency. however, transactions demand money remains vibrant almost throughout a year, whatever the economic situation might be. This is the reason why Baumol in 1952 and Tobin in 1956, separately took up the case for the transactions demand for money so as to explain its operation through a more realistic perspective, with the help of the inventory-theoretic approach (Mishkin, 2004).
The present paper tries to explore the subject of transactions demand for money from an inventory-theoretic approach as was introduced by Baumol and Tobin separately. In addition, it also includes the criticisms, as raised by many eminent observers, which have followed their adaptation.
The inventory theoretic approach is closely associated with the names of Baumol and Tobin, who had explained the theory behind the transactions demand money with the help of the same. According to the theory developed by the two observers, the transactions demand money depends upon some factors mentioned as under –
4. The opportunity cost of withdrawing or borrowing the sum for making payments – suppose the payments are made from bank deposits or borrowings made by the individual, so that the opportunity cost in this regard is, the rate of interest foregone on the amount of cash withdrawn.