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21 January, 07:03

Only one commercial bank in the banking system has an excess reserve, and its excess reserve is $400,000. This bank makes a new loan of $300,000 and keeps an excess reserve of $100,000. If the required reserve ratio for all banks is 12.5 percent, the potential expansion of the money supply from this new loan is

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  1. 21 January, 09:50
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    money supply will increase by 2,400,000

    Explanation:

    the expansion f the money supply will be:

    the money multiplier will be:

    1/reserve ratio = 1/0.125 = 8

    300,000 x 8 = 2,400,000

    The reasoning for the multiplier effect is the following:

    once the money is received, it will be used, and the person who receive the cash will deposit their proceeds.

    This amount, can generate a new loan for, the remainder after subtracting the required reserve.

    300,000 - 12.5% = 262,500

    And this, once used will also end in a deposit. This opens the posibility for another loan, after reducing the reserve

    262,500 - 12.5% = 229,687.5‬

    This can be reapeat again and again and the limit for this is the formula state above:

    multiplier effect = 1/reserve ratio
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