Economies of Scale in Cash Balances Reconsidered

Renewed interest in the demand for money has resulted in the clarification of a number of issues and has focused attention more sharply on some others. One subject of dispute has been the existence of economies of scale in the demand function for money by business firms. A familiar version of the quantity theory of money, M = kY, suggests the absence of economies of scale. Our own approach, the wealth adjustment model, reaches a very similar conclusion. It implies that — to a first approximation — the demand for money estimated from cross-sections of business firms is linear in the logarithms and unit elastic with respect to sales or transactions. This proposition is supported by a substantial body of evidence from cross-section and time series regressions.