The central bank in Hamsterville has bought $\$ 100$ in bonds from a bank. The reserve requirement is $25 \%$.

What is the maximum possible change in the money supply?
Choose 1 answer:
(A) The money supply increases by $\$ 200$
(B) The money supply increases by $\$ 400$.
(C) The money supply increases by $\$ 100$
(D) The money supply decreases by $\$ 400$.
(E) The money supply decreases by $\$ 100$

Question

The central bank in Hamsterville has bought $\$ 100$ in bonds from a bank. The reserve requirement is $25 \%$.

What is the maximum possible change in the money supply?
Choose 1 answer:
(A) The money supply increases by $\$ 200$
(B) The money supply increases by $\$ 400$.
(C) The money supply increases by $\$ 100$
(D) The money supply decreases by $\$ 400$.
(E) The money supply decreases by $\$ 100$

Accepted Answer

∻Solution by Steps∻ ‖ step 1 ⋮ To determine the maximum possible change in the money supply, we need to use the money multiplier formula. The money multiplier is given by $ \frac{1}{\text{reserve requirement}} $. ‖ ‖ step 2 ⋮ The reserve requirement is 25%, or 0.25. Therefore, the money multiplier is $ \frac{1}{0.25} = 4 $. ‖ ‖ step 3 ⋮ The central bank has bought $100 in bonds. The maximum possible change in the money supply is the product of the money multiplier and the amount of bonds bought: $ 4 \times 100 = 400 $. ‖ ∻Answer∻ ***B*** ∻Key Concept∻ ⚹Money Multiplier⚹ ∻Explanation∻ ⚹The money multiplier effect shows how an initial change in the money supply can lead to a larger change in the total money supply. In this case, a reserve requirement of 25% results in a money multiplier of 4, leading to a maximum possible increase in the money supply of $400 when the central bank buys $100 in bonds.⚹◊What formula is used to calculate the change in the money supply when the central bank buys bonds from a bank in relation to the reserve requirement?⍭ Generate me a similar question◊

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