11 October 2009
How do you calculate the simple money multiplier and the money supply?
Posted by admin under: Economics .
Here is the facts to help with this
reserve ratio =5% deposits =$10,000 What do I do to get the simple money multiplier of this problem and then the money supply of this problem? If you know how answer soon I need this to be able to send in my on-line homework tonight. Thanks
I thought you would do this 5% would be a 20 multiplier 10,000 divided by 20=500 reserve would be 500 which leaves 9,500 to be lent out so money supply grows to 19,500. Aren’t I right?
Then potential money supply =money multiplier (20) times Initial deposit (10,000) That equals 200,000.
Come on math teacher ,students, economic teacher and students , Business majors tell me am I right
Related Posts:
One Comment so far...
senb Says:
14 October 2009 at 3:12 am.
Additional details provided by you is wrong or your original input was wrong. Originally you posted:reserve ratio =5% deposits =$10,000. Now you post initial deposit is 10,000. Make up your mind: Is 10,000 the initial deposit or 5% of deposit as you posted first? If 10,000 is initial deposit, with money multiplier of 20, money supply is $200,000. Then only you can be correct. So take care.
Now read my original answer again carefully:
Money multiplier is 20 and money supply is $4,000,000.
How?
Reserve ratio is 5% of deposit.
So, deposit/ credit creation will be (1-0.05)*D +(1-0.05)^2*D + (1-0.05)^3 *D+ ………+(1-0.05)^n*D
= {1 – (1-0.05)^n}*D / {1 – (1-0.05)}
= D / 0.05 = D8100/ 5 = D * 20.
So with deposits of D, the credit creation is 20 times the original deposit.
Now what was the original deposit, D? You say 5% of D is $10,000. Therefore, D= $200,000.
Thus money supply should be 20 times of that
0r, 20*D= $4,000,000. OK
The teachers has tricked you by writing
reserve ratio=5% of deposit=$10,000
If he had written separetly reserve ratio is 5% of deposit and %5 od deposit = $10,000 you would have had no problem.
Notes:
The most common mechanism used to generate money is typically called the money multiplier. It measures the amount by which the commercial banking system increases the money supply. To control the amount of money created by the system, central banks place reserve ratios on the commercial banks which set the proportion of primary deposits the banks may not lend out.
It is sometimes said that banks make tremendous profits through the deposit multiplier effect. One should however keep in mind that for every additional fraction of deposit banks not only have additional income from extra advances but also extra expenses as extra deposits are their liabilities. For example, a reserve of $1,000,000 will allow banks to make almost $9,000,000 of advances if the reserve ratio is 10%. They will receive income on 9x the reserves, but also pay interest on 10x the same reserves as well.