Question

A bank will often hold government securities as an asset. If a bank were to sell S500,000 in government securities to an individual who paid for the bond in cash and the bank placed this cash in its vault, by how much would the money supply change as a result? a. It would increase by $500,000 multiplied by the reciprocal of the required reserve ratio. b. It would decrease by $500,000 multiplied by the reciprocal of the required reserve ratio. c. There would be no change to the money supply. d. It would increase by $500,000. e. It would decrease by $500,000.

Answer 1

Answer:a.

It would increase by $500,000 multiplied by the reciprocal of the required reserve ratio.

Explanation:

A bank will often hold government securities as an asset. If a bank were to sell S500,000 in government securities to an individual who paid for the bond in cash and the bank placed this cash in its vault, by how much would the money supply change as a result  -  It would increase by $500,000 multiplied by the reciprocal of the required reserve ratio.

The money supply is the entire stock of currency and other liquid instruments circulating in a country's economy and is given by the formula:

MONEY SUPPLY = RESERVES X MONEY MULTIPLIER

Therefore the bank reserves increasing in the scenario will increase money supplier by the effect of the money multiplier or the reciprocal of the required reserve ratio.