Question

Suppose Janice takes $4,000 in coins to the bank to deposit into her checking account. Assume the reserve requirement at all banks is 20%. When Janice deposits the $4,000 into the bank, the bank can lend Mary, another one of the bank's customers, $ Suppose Mary takes the loan and use it to buy a used car from Susan. When Susan deposits the check in her bank, Susan's bank can lend $ to Eva, another one of the bank's customers. out When Eva spends her loan, and the person who receives that money deposits it into her bank, $ must be kept on reserve and $ can be loaned out Once this loan is made, the overall increase in the money supply resulting from the Initial $4,000 deposit is $ will have been created overall Do NOT press Enter after typing the answer in each Us Tab or take the cursor to the next coll) Answer in whole numbers ASSIGNMENT PROGRESS. Money

Answer 1

Whenever someone deposits any amount in any bank, then the bank cannot lend the whole amount to someone else. They need to keep a proportion of the deposits as reserves, in case someone comes to withdraw the money from the bank, so the bank should have cash with it. Usually not the entire amount is retained as reserves but just a proportion of it as it is believed that not all depositors would come to withdraw at the same time. So the remaining amount is used to lend to other customers. The proportion which the banks need to keep with themselves is usually determined by the central bank and is known as reserve ratio or reserve requirement.

As per the given information, the reserve requirement at all banks is 20%, so whatever the banks will receive as deposits, they will have to keep 20% of that amount with themselves as reserve requirements. So if $100 is deposited in the bank, then banks will have to keep $20 as reserves and can only lend $80 as loans.

When Janice deposits $4000 into the bank, then the bank needs to keep 20% of it as reserves and can lend the remaining 80%. So 20% of 4000 is 800, so the bank will have to keep $800 as reserves and can lend the remaining (4000-800) = $3200 as loans. So, when Janice deposits $4000, the bank can lend Mary, another one of the banks customers, $3200.

Suppose Mary takes the loan of $3200 and uses it to buy a used car from Susan. When Susan deposits this $3200 into bank, the bank will keep 20% of 3200 as reserves and will lend the rest. 20% of 3200 is 640. So the bank will keep $640 as reserves and can lend the remaining (3200-640=2560) $2560. So, when Susan deposits the check in bank, Susan's bank can lend $2560 to Eva, another one of bank's customers.

When Eva spends her loan and the person who receives that money of $2560 , deposits it into her bank, 20% of 2560 must be kept as reserve which is equal to $512 which must be kept as reserve and 80% of 2560 can be loaned out which is equal to $2048 (2560-512=2048). So $512 must be kept as reserve and $2048 can be loaned out.

Once this loan is made, the overall increase in the money supply resulting from initial $4000 deposit will be equal to the sum total of all the deposits that take place successively due to this initial $4000 deposit. So the total deposits equal to :

4000 + 3200 + 2560 + 2048 = 11808

So, overall $11808 would have been created once this last loan is made. The last loan amount would also be included in the money supply as this money is going out into the economy in circulation and all the money that is in circulation is included in money supply. So an initial deposit of $4000 creates a much larger money supply in the economy through the multiplier process.

The process through which banks lend money and help to increase/multiply the money supply in the economy is known as multiplier process. If this process keeps going on even further than stated in this question, then the total money supply created in the economy would be multiplier times the initial deposit.

The value of multiplier is calculated as: 1/reserve requirement.

As per the given information, multiplier = (1/20%) = (1/20) ×100 = 5

So final money supply will be five times of the initial deposit if this process continues further.

The value of money supply is:

Money supply = multiplier × initial deposit = (1/reserve requirement) × initial deposit

As per given information,

Money supply = 5 × 4000 = $20000

Or money supply = (1/20%) × 4000 = $20000