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Money Supply Calculations

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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?

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.

Solution Preview

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 ...

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