The reserve requirement in Petmeckistan is $20 \%$.
If the central bank buys $\$ 1000$ in bonds, what is the maximum possible change in the money supply?

Choose 1 answer:
(A) The money supply increases by $\$ 1000$
(B) The money supply increases by $\$ 5000$.
(C) The money supply decreases by $\$ 1000$
(D) The money supply decreases by $\$ 5000$.
(E) The money supply increases by $\$ 4000$

Question

The reserve requirement in Petmeckistan is $20 \%$.
If the central bank buys $\$ 1000$ in bonds, what is the maximum possible change in the money supply?

Choose 1 answer:
(A) The money supply increases by $\$ 1000$
(B) The money supply increases by $\$ 5000$.
(C) The money supply decreases by $\$ 1000$
(D) The money supply decreases by $\$ 5000$.
(E) The money supply increases by $\$ 4000$

Accepted Answer

∻Answer∻ ⚹ (B) The money supply increases by $5000 ⚹ ∻Solution∻ ‖ a ⋮ Money Multiplier Formula: The money multiplier (m) is the inverse of the reserve requirement ratio (rr). In this case, $ m = \frac{1}{rr} = \frac{1}{0.20} = 5 $. ‖ ‖ b ⋮ Maximum Change in Money Supply: The maximum change in the money supply is calculated by multiplying the initial change in reserves (the central bank's purchase of bonds) by the money multiplier. So, $ \Delta MS = m imes ext{Initial Change in Reserves} = 5 imes \$1000 = \$5000 $. ‖ ∻Key Concept∻ ⚹ Money Multiplier ⚹ ∻Explanation∻ ⚹ The money multiplier effect explains how an initial change in the monetary base can lead to a greater change in the total money supply. ⚹◊What is the formula to calculate the maximum change in the money supply after the central bank buys bonds?⍭ Generate me a similar question◊$

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