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Chapter 10: Problem 2

Fred creates \(\$ 2,000\) in currency with the snap of his fingers and deposits it in bank A. The reserve requirement is 10 percent By how much does the money supply increase?

Short Answer

Expert verified
The total increase in the money supply will be $20,000.

Step by step solution

01

Calculate Reserved Amount

First, determine the amount the bank needs to keep in reserves based on the reserve requirement. It can be calculated by multiplying the deposit amount with the reserve requirement. So, for the deposit of $2000 with a reserve requirement of 10%, the reserve will be $2000 * 0.10 = $200.
02

Find Money Available for Lending

Next, calculate the amount available for lending by subtracting the reserved amount from the total deposit. That is $2000 - $200 = $1800.
03

Calculate Total Money Supply Increase

Finally, calculate the potential increase in the money supply, recognizing that the deposit can be lent out, redeposited, and re-lent, each time with a reserve requirement of 10%. This is calculated by dividing the original deposit by the reserve requirement. Therefore, the total increase in the money supply is $2000 / 0.10 = $20,000. This is because each time money is deposited, 90% of it can be loaned out and potentially become a new deposit in the banking system.

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