Chapter 14, Problem 8P

To determine

Concept Introduction:

Money Supply:

It refers to that amount of money which is in circulation within the economy at a particular point of time. It includes cash currency and all the liquid assets which can be converted into cash on demand.

Increase in money supply and relation between public’s desire for holding currency and money multiplier.

Explanation of Solution

Given,

Public holds 50% in the form of currency.

Required reserve ratio is 20%.

New cash deposit is $500.

Round	Deposits($) $\left(\text{A}\right)$	Required Reserves($) $\left(\left(\text{A}\right)\times \frac{20}{100}\right)$$\left(\text{B}\right)$	Excess Reserves($) $\left(\text{A}\right)-\left(\text{B}\right)$	Loans($) $\left(\text{C}\right)$	Held as Currency($) $\left(\left(\text{C}\right)\times \frac{50}{100}\right)$
1	500	100	400	400	200
2	200	40	160	160	80
3	80	16	64	64	32
4	32	6.40	25.60	25.60	12.80
5	12.80	2.56	10.24	10.24	5.12
6	5.12	1.02	4.10	4.10	2.05
7	2.05	0.41	1.64	1.64	0.82
8	0.82	0.16	0.66	0.66	0.33
9	0.33	0.07	0.26	0.26	0.13
10	0.13	0.03	0.10	0.10	0.05
Total	833.25	166.65	666.60	666.60	333.30

Table (1)

Round	Deposits($) $\left(\text{A}\right)$	Required Reserves($) $\left(\left(\text{A}\right)\times \frac{20}{100}\right)$$\left(\text{B}\right)$	Excess Reserves($) $\left(\text{A}\right)-\left(\text{B}\right)$	Loans($) $\left(\text{C}\right)$	Held as Currency($) $\left(\left(\text{C}\right)\times \frac{50}{100}\right)$
1	500	100	400	400	200
2	200	40	160	160	80
3	80	16	64	64	32
4	32	6.40	25.60	25.60	12.80
5	12.80	2.56	10.24	10.24	5.12
6	5.12	1.02	4.10	4.10	2.05
7	2.05	0.41	1.64	1.64	0.82
8	0.82	0.16	0.66	0.66	0.33
9	0.33	0.07	0.26	0.26	0.13
10	0.13	0.03	0.10	0.10	0.05
Total	833.25	166.65	666.60	666.60	333.30

Table (1)

According to the calculated data, demand deposits have increased to $833.25 from $500, loan has increased to $666.60 from $400, and currency held by public has increased to $333.30 from $200.

If public does not hold any currency:

Formula to calculate increase in money supply,

$\text{Increase}\text{in}\text{Money}\text{Supply}=\frac{\text{Initial}\text{Deposit}}{\text{Reserve}\text{Ratio}}-\text{Initial}\text{Deposit}$

Substitute $500 for initial deposit and 20% for reserve ratio.

$\begin{array}{c}\text{Increase}\text{in}\text{Money}\text{Supply}=\frac{\$500}{0.2}-\$500\\ =\$2,000\end{array}$

Therefore, money supply will be increased to $2,000 and deposits in the bank will also increase to $2,500 $\left(\$2,000+\$500\right)$ . So, if more money is supplied to public as a loan then it will reduce the money multiplier.