Question

Suppose that the required reserve ratio is 0.20. If a customer makes a deposit of $10 million in a bank, then the money supply could potentially

decrease by $25 million

decrease by $40 million

increase by $32 million

increase by $40 million

Answer 1

Since the required reserve ratio is 0.20.

If a customer makes a deposit of $10 million in a bank,

Money multiplier=1/ required reserve

=1/0.2

=5

Since an individual deposit= $10 million and reserve

=0.20 * deposits

=0.20*10

=$2 millons

Loan amount =$8 millions

then the money supply could potentially increase by= money multiplier* loan amount

=5*$8 million

=$40 millions

If a customer makes a deposit of $10 million in a bank, then the money supply could potentially increase by $40 million.

Hence option fourth is the correct answer.