Question

What will happen to the money supply under the following circumstances in a checkable-deposits-only system? a. The required reserve ratio is \(25 \%,\) and a depositor withdraws \(\$ 700\) from his checkable bank deposit. b. The required reserve ratio is \(5 \%,\) and a depositor withdraws \(\$ 700\) from his checkable bank deposit. c. The required reserve ratio is \(20 \%,\) and a customer deposits \(\$ 750\) to her checkable bank deposit. d. The required reserve ratio is \(10 \%,\) and a customer deposits \(\$ 600\) to her checkable bank deposit.

Short answer

a. Withdrawing $700 with a 25% reserve ratio. b. Withdrawing $700 with a 5% reserve ratio. c. Depositing $750 with a 20% reserve ratio. d. Depositing $600 with a 10% reserve ratio. Answer: a. The money supply will decrease by $2,800. b. The money supply will decrease by $14,000. c. The money supply will increase by $3,750. d. The money supply will increase by $6,000.

Step-by-step solution

1. Calculate the initial money supply

To calculate the initial money supply, we need to know the total amount of checkable deposits and the reserve ratio. The total money supply can be found using the money multiplier formula: $ M_0 = \frac{1}{Required \ Reserve \ Ratio} $

a. Withdrawing \(\$700\) with a \(25\%\) reserve ratio

First, calculate the initial money supply using the formula: $ M_0 = \frac{1}{0.25} = 4 $ Now, calculate the change in money supply after the withdrawal: $ ΔM = -\$700 \times 4 = -\$2800 $ Therefore, the money supply will decrease by \(\$2800\).

b. Withdrawing \(\$700\) with a \(5\%\) reserve ratio

First, calculate the initial money supply using the formula: $ M_0 = \frac{1}{0.05} = 20 $ Now, calculate the change in money supply after the withdrawal: $ ΔM = -\$700 \times 20 = -\$14{,}000 $ Therefore, the money supply will decrease by \(\$14{,}000\).

c. Depositing \(\$750\) with a \(20\%\) reserve ratio

First, calculate the initial money supply using the formula: $ M_0 = \frac{1}{0.2} = 5 $ Now, calculate the change in money supply after the deposit: $ ΔM = \$750 \times 5 = \$3750 $ Therefore, the money supply will increase by \(\$3750\).

d. Depositing \(\$600\) with a \(10\%\) reserve ratio

First, calculate the initial money supply using the formula: $ M_0 = \frac{1}{0.1} = 10 $ Now, calculate the change in money supply after the deposit: $ ΔM = \$600 \times 10 = \$6{,}000 $ Therefore, the money supply will increase by \(\$6{,}000\).