Final answer:
The potential increase in the money supply due to a $2 million increase in bank reserves, with an 8% required reserve ratio, is calculated to be $25 million using the money multiplier concept.
Step-by-step explanation:
The student's question concerns the potential change in the money supply given an increase in bank reserves and a specific required reserve ratio. If reserves increase by $2 million and the required reserve ratio is 8%, the change in the money supply can be calculated using the money multiplier concept.
The money multiplier is the reciprocal of the required reserve ratio. Therefore, the money multiplier in this case is 1 / 0.08, or 12.5. To find the total potential increase in the money supply, we multiply the increase in reserves by the money multiplier. The total potential change in the M1 money supply is therefore $2 million times 12.5, which equals $25 million.
In reality, not all of the excess reserves may be lent out and there are other factors that could influence the actual change in the money supply, such as the preferences of banks and borrowers, and other financial market conditions.