Example Question #2 : Money Supply
At a particular bank, the reserve ratio is 10% and excess reserves are $300. The maximum expansion of the money supply that can be generated by that bank is ________.
The money multiplier is equal to 1/r, where r is the reserve ratio. In this example, the money multiplier is 1/.1 = 10.
Since the bank has $300 in excess reserves, it can loan out the entire $300, which we then multiply by the money multipler to find the total expansion of the money supply:
The maximum expansion of the money supply generated by that bank is therefore $3000.
If you selected $300, you may have forgotten to multiply by the money multipler.
If you selected $30, you may have multiplied by r rather than 1/r.
If you selected $30,000, you may have thought that the reserve ratio was 1 percent rather than 10 percent.