Answer:
Increase directly by $1 million and an additional lending capacity of $4 million will be created for the banking system.
Explanation:
The formula for increase in money supply is
Increase in money supply = (1 / Required reserve ratio) * Excess reserve.
Now, we have, required reserve ratio of 20%.
That means, out of $1 million deposit, required reserve = ($1,000,000 * 0.20) = $200,000.
Now, we knew that, Total reserve = required reserve + excess reserve
Total Reserve = $1,000,000 and required reserve = $200,000.
So, Excess reserve = $1,000,000 - $200,000 = $800,000.
Now, Increase in money supply = (1 / 0.20) * $800,000 = $4 million.
That means,
If the public deposits this amount into transactions accounts, the money supply will:
Increase directly by $1 million and an additional lending capacity of $4 million will be created for the banking system.
