The Modified Baumol Equation: Theory and Evidence

T. Tavor, Limor Gonen, M. Weber, U. Spiegel

Research output: Contribution to journalArticlepeer-review


Baumol developed an equation of demand for money for the transaction motive. It is affected positively by cost per
withdrawal and negatively by the interest loss resulting from holding cash. The present paper suggests modifying the
basic and simplified Baumol approach by adding another element to the transaction equation. Availability of cash
encourages spontaneous purchases resulting in customer losses. Through cost minimization with respect to three elements
instead of two as in the original Baumol equation, a new modified Baumol equation was created. It is examined by using
an empirical data set and the results support the modified version of the Baumol equation. Customers respond positively
to cash availability when they spend more on luxury goods. This is prominent especially among unmarried and most
likely young customers. Due to high-income elasticity, spontaneous purchasing is higher among wealthier customers and
full-time workers who maintain a steady and secure employment position. Since such customers have a weakness for
spontaneously and sometimes even carelessly buying luxury items, from their point of view they create a good and
efficient buffer by decreasing the available cash in hand and thereby reducing or possibly even preventing their wasteful
behavior. The new version is robust and statistically more significant than the original equation presented in 1952.
Original languageEnglish
Pages (from-to)25-33
JournalReview of European Studies
Issue number1
StatePublished - 2018


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