AP Macroeconomics : How to find the effect of reserve requirements on money supply

Study concepts, example questions & explanations for AP Macroeconomics

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Example Questions

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 ________.

Possible Answers:

$30,000

$300

$30

$3000

Correct answer:

$3000

Explanation:

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.

 

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