(a)
Deposits = $1 million
Desired reserves = $40,000
Calculate the reserve ratio -
Reserve ratio = Desired reserves/Deposits
Reserve ratio = $40,000/$1,000,000
Reserve ratio = 0.04 or 4%
So,
The reserve ratio in the banking system is 4%.
(b)
New deposit = $100,000
Reserve ratio = 0.04
Desired reserves = New deposits * Reserve ratio = $100,000 * 0.04 = $4,000
Excess reserves = New deposit - Desired reserves = $100,000 - $4,000 = $96,000
So,
If a further $100,000 is deposited in this bank then the bank's desired reserves increases by $4,000 while the bank's excess reserves increases by $96,000.
(c)
Calculate the money multiplier -
Money multiplier = 1/Reserve ratio = 1/0.04 = 25
The money multiplier is 25.
Calculate the final increase in the money supply -
Final increase in money supply = Increase in excess reserves * money multiplier
Final increase in money supply = $96,000 * 25 = $2,400,000
The final increase in the money supply is $2,400,000 or $2.4 million.
Thus,
The banking system can increase the money supply by this bank's initial amount of $96,000 multiplied by the money multiplier of 25 for a final increase in the money supply of $2.4 million.
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