Suppose you win on a scratch-off lottery ticket and you decide to put all of you

Question

Suppose you win on a scratch-off lottery ticket and you decide to put all of your $2,500 winnings in the bank. The reserve requirement is 5%. What is the maximum possible increase in the money supply as a result of your bank deposit?

Which events could cause the increase in the money supply to be less than its potential? Check all that apply.

Banks choose to loan out all excess reserves.

All money loaned out is deposited back into the banking system.

Banks decide to keep some excess reserves on hand.

Some loan recipients choose to hold some cash instead of depositing all of it in banks.

Explanation / Answer

Since he deposited his entire amount he won into the bank the bank's deposit increased by $2500.Now according to the formula for simple deposit multiplier where change in deposits = 1/rr * change in reserves.

change in deposits = 2500/0.05

change in deposits = 50,000.

Since this is the case of a simple deposit multiplier where public holds no currency, simple deposit multiplier is same as the money multiplier thus as a result of $2500 increase in deposits money supply increases by $50,000.

Money supply would increase by less than potential in the following cases:

Banks decide to keep some excess reserves on hand.

some loan recipients choose to hold some cash instead of depositing all of it in banks.

Both these events prevent the flow of money from bank to individuals and from individuals to banks thus restricting the growth of money supply.In the 1st case banks do not lend the entire excess reserves to the public thus restricting the amount of loans created by the banks.In the 2nd case individuals hold currency with themselves and not depositing the entire amount thus again restricting the amount of loans created and hence restricting the amount of money supply in the economy.

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