Question

1. Assume the reserve requirement is 10%. First National Bank receives a deposit of $5,400. If there is no slippage, how much could the money supply expand? Explain and show your work. (3 points for correct math. 7 points for analysis)

Answer 1

Answer: Money supply will increase by $54,000

Explanation:

Required reserve ration or r= 10% = 0.10

Initial deposits = $5400

We use the money multiplier formula to find out the value of the multiplier. It is given by,

$m=\frac{1}{r} =\frac{1}{0.10} =10$

Money multiplier shows us how much does the supply of money change for a change in the deposits. So, using the value of the multiplier = 10, we have change in money supply of,

$m=\frac{Change in Money supply}{Change in deposits}$

$10=\frac{Change in money supply}{ 5400}$

$Change in money supply = 5400*10= 54,000$

Thus, the money supply in the economy will increase by $54,000