Question

While Jon is walking to school one morning, a helicopter flying overhead drops a $20 bill. Not knowing how to return it, Jon keeps the money and deposits it in his bank. (No one in this economy holds currency.) If the bank keeps 25 percent of its money in reserves:a. How much money can the bank initially lend out? b. After this initial transaction, by how much is the money in the economy changed? c. What's the money multiplier? d. How much money will eventually be created by the banking system from Jon's $20?

Answer 1

Answer:

(a) $15

(b) $35

(c) 4

(d) $80

Explanation:

Given that,

Initial deposit = $20 bill

Required reserve ratio = 25%

(a) Money lend out by bank is as follows:

= Amount of deposit - Reserve requirement

= $20 - ($20 × 0.25)

= $20 - $5

= $15

(b) Money in the economy changed:

= Initial deposit + Amount of money lend out by bank

= $20 + $15

= $35

(c) Money multiplier:

= 1/ Required reserve ratio

= 1/ 0.25

= 4

(d) Money will eventually be created by the banking system:

= Change in deposits × Money multiplier

= $20 × 4

= $80