Question

Now suppose instead that withdraws $400 from her checking account and uses $280 of this money to pay her federal income tax. After that, she uses $100 to buy a set of used golf clubs from her neighbor who deposits it into his checking account. Finally, she deposits the remaining cash from the $400 withdrawal into her savings account. By what dollar amount does the country's money supply change as a result of Jane's actions?

Answer 1

Answer:

$300 has been reduced from the money supply.

Explanation:

The taxes act as leakage from the circular flow of money. Unless they are spent and injected back as government spending they would be treated as a leakage that has left the circular flow.

Similar effect happens with the savings amount. A saving is a leakage and thus the remaining amount which is $20 after paying for golf clubs and taxes can also be said to have left the circular flow of income and so reducing money supply.

$100 of the original $400 is still left in the flow and money supply as it is still in the checking account after the transaction.

Hope that helps.