Final answer:
As the reserve ratio decreases, the money multiplier increases because banks can lend more money relative to their reserves, leading to an expanded money supply through the lending process.
option a is the correct
Step-by-step explanation:
When discussing how changes in reserve requirements affect the money supply, we refer to the concept of the money multiplier. The money multiplier indicates how much the money supply expands with each dollar of reserves. When the reserve ratio decreases, banks are required to hold less money in reserve and can loan out a greater portion of their deposits. This increase in the potential amount to be lent out leads to a multiplication effect throughout the banking system, where each new deposit can result in multiple loans and an expanded money supply. Therefore, as the reserve ratio decreases, the money multiplier increases.
Conversely, if there is an increase in the reserve requirement, banks have to hold more money in reserves, reducing the amount available to lend out. This restrictive measure would lead to a lower money multiplier because less money would be multiplying through the economy.
In summary, the reserve ratio is inversely related to the money multiplier: a lower reserve ratio means a higher money multiplier because banks can lend out more money relative to their reserves, thus potentially creating more money through the lending process.