Final answer:
The money multiplier is the amount of money that the banking system can generate from each $1 of bank reserves. It is calculated using the formula 1/reserve ratio. This concept is important for understanding how changes in bank reserves can affect the money supply in an economy.
Step-by-step explanation:
The money multiplier is a concept in economics that represents the amount of money that the banking system can generate from each $1 of bank reserves. It is calculated using the formula 1/reserve ratio, where the reserve ratio is the fraction of deposits that the bank holds as reserves.For example, if the reserve ratio is 20% (or 0.2), the money multiplier would be 1/0.2 = 5. This means that for every $1 of reserves, the banking system can generate $5 of money supply.The money multiplier is important because it shows how changes in bank reserves can affect the money supply in an economy. When banks make loans and create new deposits, it leads to a multiplier effect where more money is created and circulated in the economy.