Question

In exchange for his many years of hard work and devotion, National Corp Inc. gives

Dave $100,000 in T-bonds. Dave sells these bonds to the Fed, and the Fed deposits the
money in Dave's bank account.
Darlene uses the money to buy a very expensive pair of soccer cleats from Arthur. Arthur deposits this money in his bank account. His bank holds onto 12% of the deposit and lends the rest out. How much does the money supply increase as a result of this step?

Answer 1

Answer: The money supply will increase by a maximum of $733,333.33 as a result of Darlene's purchase of soccer cleats from Arthur

Step-by-step explanation:

The money supply will increase by the amount of the loan that the bank makes, since this loan creates new money in the banking system through the money multiplier effect.

Assuming that Arthur deposits the full $100,000 from Darlene into his bank account, the bank will hold onto 12% as reserves and lend out the remaining 88%.

So, the amount that the bank will lend out is:

$100,000 x 0.88 = $88,000

Assuming a reserve requirement ratio of 10%, the initial deposit of $100,000 would have increased the money supply by:

1/0.10 x $100,000 = $1,000,000

However, since the bank is holding onto 12% of the deposit, the maximum amount that the money supply can increase is:

1/0.12 x $88,000 = $733,333.33

Therefore, the money supply will increase by a maximum of $733,333.33 as a result of Darlene's purchase of soccer cleats from Arthur.