Chapter 5R, Problem 16MCQ

To determine

The correct option that defines money multiplier if rr represents the reserve ratio.

Answer to Problem 16MCQ

Option b is correct.

Explanation of Solution

Explanation for the correct option:

c.

The money multiplier refers to the ratio of the money supply to the monetary base. If all cash is deposited in the bank and there is no excess reserve then it is equal to 1/rr. Therefore, the option is correct.

Explanation for incorrect options:

a.

The Reserve ratio is represented by rr. The money multiplier is equal to 1/rr if all cash is deposited in the bank and there is no excess reserve. Therefore, option a is incorrect.

b.

The money multiplier represents the change in money supply if the monetary base is changed. It cannot be represented by 1-rr. Therefore, option b is incorrect.

d.

The squared reserve ratio is not equivalent to a money multiplier. Therefore, option d is incorrect.

e.

The monetary base is the sum of the circulation of currency and the bank’s reserve. The money multiplier can be determined by 1/rr which means the change in reserve ratio will change the monetary base. Therefore, option e is incorrect.

Economics Concept Introduction

Liquid assets: Assets that can be converted into cash or cash equivalents in a very short span of time are referred to as liquid assets.

Required reserve ratio: Required reserve ratio refers to the portion of the total money deposits that are collected by the banks. This amount cannot be used for further lending or investing purposes. The percentage is decided by the Federal Reserve.