Based on the above table, an open market operation in which the Fed purchased $1

Question

Based on the above table, an open market operation in which the Fed purchased $100,000 of government securities would lead to a maximum potential expansion of the money supply of $100,000. lead to a maximum potential expansion of the money supply of $1 million. create a reserve deficiency for the banking system. cause demand deposits to fall by $100,000. An economy in long-run equilibrium experiences an increase m aggregate demand. According to the classical model, the price level will increase, but real GDP will decrease. the price level will rise first then real GDP will increase the price level will increase, but real GDP will not change the price level and real GDP will increase at the same time.

Explanation / Answer

(16) (B)

Reserve-deposit ratio = $200,000 / $2,000,000 = 0.10 or 10%

Purchase of government securities will lead to a monetary expansion, and maximum amount of expansion will be:

= Initial increase / Reserve-deposit ratio

= $100,000 / 0.1 = $1,000,000

(17) (B)

As per Classical model, prices are fully flexible in long run. So, initially the price level will increase and then real GDP will increase.

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