Question

Consider a country where all money is currently held as cash and the money supply has a value of $7,000. A banking system is developed, and the residents of the country deposit the $7,000 of cash into the banking system and decide they no longer want to hold any cash. If the reserve ratio is equal to 10%, then the banking system has the ability to create $_______ of new money and the money supply in the economy will be equal to $________ .

Answer 1

Answer: $70,000 of new money and the money supply in the economy will be equal to $70,000

Step-by-step explanation:

The reserve ratio is the percentage of deposit the banks are expected to keep for demand by customer and the remaining percentage is made available for loan to customer.

In the above scenario the reserve ratio is 10% which gives a multiplier of 1/0.1 which gives 10. The money supply is the deposit multiply by the the multiplier $7000*10 which gives $70,000 as money supply.