Suppose the entire economy contains $5000 worth of one-dollar bills.
(a) If people fail to deposit any of the dollars, but instead hold all $5000 as currency, how large is the money supply?
(b) If people deposit the entire $5000 worth of bills in banks that are required to observe a 100% reserve requirement, how large is the money supply?
(c) If people deposit the entire $5000 worth of bills in banks that are required to observe a 20% reserve requirement, how large is the money supply?
(d) In part (c), what portion of the money supply was created due to banks?
(e) If people deposit the entire $5000 worth of bills in banks that are required to observe a 10% reserve requirement, how large could the money supply become?

a) The amount of $5000 is the money supply.
b) The Money Multiplier (MM) measures the amount that the money supply could change as a result of banks creating new loans. The formula for MM is 1/Required ...

Solution Summary

This solution shows how to calculate a country's money supply, given the amount of currency in circulation and the size of its Required Reserve Ratio (RRR). All answers are supported by detailed calculations.

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