9.9 Baumol’s Model Illustrated
Here is a graph of Baumol’s model. Take careful not of the assumptions stated immediately below the graph. The Blue lines represent the smooth usage of the funds over time. Thus, the interval between which the funds are replenished (red lines) are uniform – at least theoretically as per this graph.
Assumptions:
- Cash outflow is uniform, or smooth, over the period
- Length of each order period/interval is the same
- Amount ordered each time is the same
- The point of origin in the diagram need not be equal to $0. Instead, it represents the minimal point, which the firm will allow its cash to reach.
- The firm’s opportunity cost is the same rate as its borrowing cost.