Question

In Macroland, currency held by the public is 2,000 econs, bank reserves are 400 econs, and the desired reserve/deposit ratio is 12.5 percent. If the Central Bank prints an additional 300 econs and uses this new currency to buy government bonds from the public, the money supply in Macroland will increase from ______ econs to ______ econs, assuming that the public does not wish to change the amount of currency it holds.

A. 5,200;7,600
B.5,200;2,400
C.5,000;7,400
D.25,000;28,750

Answer 1

The initial money supply in Macroland is 5,200 econs. After the Central Bank prints an additional 300 econs, assuming all other factors constant, and banks loan out to the full extent permitted by the reserve ratio, the money supply would increase to 7,900 econs, which does not match any of the provided options.

Step-by-step explanation:

The student's question pertains to the concept of the money supply and its expansion through the banking system, known as the money multiplier effect. Initially, in Macroland, the currency held by the public is 2,000 econs and bank reserves stand at 400 econs, with a reserve/deposit ratio of 12.5%. Therefore, deposits can be calculated as 400 econs / 0.125 = 3,200 econs. The initial money supply (M1) includes the currency held by the public and the deposits, so it totals 2,000 econs + 3,200 econs = 5,200 econs.

Next, the Central Bank prints an additional 300 econs to buy government bonds. This increases currency held by the public to 2,300 econs and bank reserves to 700 econs because the public's preference for currency holding does not change. Assuming the banks loan out the excess reserves to the fullest extent allowed by the reserve ratio (700 econs / 0.125 = 5,600 econs in deposits), the new money supply becomes 2,300 econs + 5,600 econs = 7,900 econs. It appears there may be a typo in the question as none of the options accurately reflects the calculated value.