Question

2. Assume that Jimmy Cash has $2000 in his checking account at Folsom Bank and he deposits $400 from his tip income in it. By what dollar amount, if any, did the i) M1 and ii) M2 change as a result of this single, isolated transaction?

Answer 1

M1 = Currency held by public + Demand deposits + other deposits (not so significant)

So, with the deposit of money, currency is converted into bank deposit which means there is no overall change in M1. Demand deposits increase by the same amount that cash holdings fall. However, there may be an increase in total money supply by a multiplier value which depends upon the reserve requirement and currency deposit ratio

M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money. M2 is a broader measure of the money supply that M1, which just include cash and checking deposits.