Question

The economy of Elmendyn contains 3,000 $1 bills. a. If people hold all money as currency, the quantity of money is $ . b. If people hold all money as demand deposits and banks maintain 100 percent reserves, the quantity of money is $ . c. If people hold equal amounts of currency and demand deposits and banks maintain 100 percent reserves, the quantity of money is $ . d. If people hold all money as demand deposits and banks maintain a reserve ratio of 20 percent, the quantity of money is $ . e. If people hold equal amounts of currency and demand deposits and banks maintain a reserve ratio of 20 percent, the quantity of money is $ .

Answer 1

(a) The quantity of money is $3,000 because people are holding all the currency.

(b) The quantity of money is $3,000 because banks are holding the full amount of demand deposits as a reserves.

(c) Quantity of money = Currency + Demand deposits

= 1,500 + 1,500

= $3,000.

(d) If banks have a reserve ratio of 20%, therefore,

money multiplier

= 1 ÷ Reserve ratio

= 1 ÷ 0.20

= 5.

So if people hold all money as demand deposits, then

Quantity of money = Money multiplier × Demand deposits

= 5 × $3,000

= $15,000

(e) Two equations must be satisfied:

C = D and 5 × ($3,000 - C) = D

Using the first equation in the second gives

5 × ($3,000 – D) = D

$15,000 – 5D = D

6D = 15000

D = 2500

C = 2500

D = 5 × ($3,000 - 2500)

= 2500

Total money supply = Currency + Demand deposits

= 2500 + 2500

= 5,000