The economy of Elmendyn contains \(2,000 \) \(1\) bills. a. If people hold all money as currency, what is the quantity of money? b. If people hold all money as demand deposits and banks maintain 100 percent reserves, what is the quantity of money? c. If people hold equal amounts of currency and demand deposits and banks maintain 100 percent reserves, what is the quantity of money? d. If people hold all money as demand deposits and banks maintain a reserve ratio of 10 percent, what is the quantity of money? e. If people hold equal amounts of currency and demand deposits and banks maintain a reserve ratio of 10 percent, what is the quantity of money?

The reserve ratio is a critical regulatory tool that dictates the minimum fraction of customer deposits that a bank must keep on hand as reserves, rather than using for loans or other investments. This rate is often set by central banks and is influential in controlling the liquidity and the ability to expand the credit supply within an economy.

For example, a reserve ratio of 10% means that for every dollar deposited into a bank account, the bank must keep 10 cents on hand, and it is free to loan out the remaining 90 cents. This is how banks generate interest income by lending out deposits they receive, which also increases the overall money supply in the economy. On the other hand, a higher reserve ratio restricts how much the banks are able to lend, thereby potentially limiting the money supply. The reserve ratio is more than just a safeguard to ensure banks can meet their liabilities; it's also a controlling mechanism for economic policy.

Demand deposits refer to the funds held in bank accounts that can be withdrawn by the account-holder at any time without any advance notice to the bank. These are a fundamental component of the money supply because they are part of the liquid funds circulating within the economy. Examples include checking accounts and other deposits against which checks can be written, as well as savings accounts that allow for immediate withdrawal.

When people choose to keep their money in the form of demand deposits, banks are able to use a portion of these deposits to make loans and create more money through the process of fractional-reserve banking. Demand deposits are not just safekeeping for people's earnings but are actively involved in the creation of additional currency through lending activities underlined by the reserve ratio.

Currency circulation encompasses all the physical money, such as coins and paper currency, that is actively being used in transactions and exchanges throughout an economy. This is the actual 'cash on hand' that people and businesses use daily. When considering the money supply, one must account for the money held as currency, which is just one part of the broader monetary base.

Currency in circulation represents a liquid asset for individuals and businesses, and it is directly affected by the actions of the central bank and the banking system. For instance, when a central bank issues more currency, the amount of physical money in circulation increases. When they decide to reduce the money supply, they withdraw currency from circulation. Currency circulation is distinct from demand deposits, as it operates outside the immediate influence of the banking system and reserve requirements, and thus, does not directly impact the money multiplier effect in the same way.

The concept of the money multiplier is at the heart of the fractional-reserve banking system. It describes how an initial deposit can lead to a greater increase in the total money supply. This multiplier effect occurs because banks hold only a fraction of deposits as reserves, as dictated by the reserve ratio, and lend out the rest.

The formula for the money multiplier is simply \( 1 / \text{{reserve ratio}} \). If the reserve ratio is 10%, the money multiplier is 10, meaning that for each dollar of reserves, the banking system can expand the money supply by 10 dollars through the process of making loans and creating new deposits. This process can significantly amplify the impact of monetary policy on the economy as it affects credit availability, consumer spending, and investment activities. However, it's also important to remember that the money multiplier is a theoretical maximum, and real-world factors such as cash leakages and changing reserve requirements can alter its efficacy.