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      Question

      Tobin’s mean-variance portfolio model predicts a

      smooth, downward-sloping speculative demand for money. This is a significant improvement over Keynes’s liquidity preference because:
      A Tobin’s model shows that individuals hold both money and bonds simultaneously at any interest rate, whereas Keynes predicted all-or-nothing portfolio switching at the critical interest rate Correct Answer Incorrect Answer
      B Tobin’s model incorporates transaction costs, whereas Keynes ignored them entirely Correct Answer Incorrect Answer
      C Tobin’s model derives money demand from utility maximisation, whereas Keynes used ad hoc behavioural assumptions about the transactions motive Correct Answer Incorrect Answer
      D Tobin’s model makes the LM curve vertical, reconciling liquidity preference with the classical quantity theory Correct Answer Incorrect Answer

      Solution

      Keynes: each individual holds either ALL money (r < critical rate) or ALL bonds (r > critical rate) — an all-or-nothing switch. The smooth aggregate demand curve only emerged from aggregating individuals with different critical rates. Tobin’s mean-variance framework: diversification is optimal at the individual level. Each person simultaneously holds both money (low risk, zero return) and bonds (higher return, higher risk), trading off expected return against variance. This generates a smooth individual demand curve — a theoretically superior foundation.

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