Question

If the banking system has $5 million in excess reserves, and the required reserve ratio is 25 percent, what is the maximum amount by which the money supply can be increased?

a. $5 million

b. $2.5 million

c. $20 million

d. $25 million

Answer 1

The answer is option 'C'.which is 20 million dollar.

Explanation:- it is given that the required reserve ratio is 25 percent and  the banking system has $5 million in excess reserves.

The money multiplier tells you the maximum amount the money supply could increase based on an increase in reserves within the banking system. The formula for the money multiplier is simply 1/r, where r = the reserve ratio. so the money multiplier(m) = 1/25% or 100/25 =4

so m = 4

now the maximum amount by which the money supply can be increased = money multiplier x  excess reserves =4 x 5 million dollar = 20 million dollar.