Question

If the target reserve ratio in the banking system is 10%, there is no cash drain, and there are no excess reserves, a new deposit of $1 will lead to an eventual expansion of the money supply of

A) $0.01.
B) $0.10.
C) $1.00.
D) $10.00.
E) $100.00.

Answer 1

If a new deposit of $1 is made and the target reserve ratio is 10%, it will lead to an eventual expansion of the money supply of $10.00.

Step-by-step explanation:

In this scenario, the target reserve ratio in the banking system is 10%. When a new deposit of $1 is made, the bank is required to hold 10% of that deposit as reserves. Therefore, the bank will keep $0.10 as reserves and can loan out the remaining $0.90. This $0.90 will then be deposited into another bank, which follows the same reserve requirement of 10%.

The process continues as each bank keeps 10% of the new deposit as reserves and loans out the remaining amount. This creates a money multiplier effect. To calculate the total expansion of the money supply, we can use the formula:

Total expansion = Initial deposit × (1 / reserve ratio)

In this case, the initial deposit is $1 and the reserve ratio is 10%. So, the total expansion of the money supply will be:

Total expansion = $1 × (1 / 0.10) = $1 × 10 = $10

Therefore, the correct answer is $10.00.