Question

If the required reserve ratio is 5%, an initial demand deposit made in a bank of $100,000 can result in an expansion in the money supply of

	a.	​$2,000,000.
	b.	​$200,000.
	c.	​$1,000,000.
	d.	​$100,000.

Answer 1

The correct answer is (a) $2,000,000

Simple money multiplier = 1/rr and here rr = required reserve ratio = 5% = 0.05

Hence Money multiplier = 1/0.05 = 20.

Thus, with the given information, Money supply = Money multiplier*Demand deposit = 20*100,000 = 2,000,000.

Hence, the correct answer is (a) $2,000,000.

Note :

In order to calculate money supply there are many more factors line Currency to deposit ratio, Excess reserve ratio. Here there is no information regarding Currency to deposit ratio, Excess reserve ratio and hence are ignored above.