The economy of Tuscaloosa has $10,000 in currency. (1). If people hold equal amo

Question

The economy of Tuscaloosa has $10,000 in currency.

(1). If people hold equal amounts as currency and demand deposits and banks maintain 100 percent reserves, what is the money supply?

10,000

(2). If people hold all money as demand deposits and banks maintain 100 percent reserves, what is the money supply?

(3). If people hold all money as demand deposits and banks maintain a reserve ratio of 20%, what is the money supply?

(4). If people hold equal amounts of currency and demand deposits and banks maintain a reserve ratio of 20%, what is the money supply?

(5). If people hold all money as currency, what is the money supply?

(6). If people hold 25% as currency and 75% as demand deposits and banks maintain a reserve ratio of 20%, what is the money supply?

Explanation / Answer

Money supply is the total amount of monetary assests available in an economy at a specific time. The standard measures usually include currency in circulation and demand deposits.

The reserve ratio on the other hand is the portion of depositors balance that bank must have on hand as cash.

Let, currency (m1) , demand deposit (m2) and reserve (m3)

Then money supply (m) = m1 + m2 - m3

Given m1 + m2 = $10000

1) m1 = m2 , so m1= m2 = $5000 , and reserve ratio = 100% hence, m3= 1 x m2 = 5000

So m = $( 5000 + 5000 - 5000) = $5000

2) m1= 0, m2= $10000 reserve ratio = 100% , m3= 10000

So m = $(10000-10000) = 0

3) m1=0 , m2= $10000, reserve ratio= 20%, m3= .2 x 10000 = 2000

So m = $(10000 - 2000) = $8000

4)

m1 = m2 , so m1= m2 = $5000 , and reserve ratio = 20% hence, m3= .2x m2 = 1000

So m = $( 5000 + 5000 - 1000) = $9000

5) m1= $10000, m2=0, m3=0

So m= $10000

6) m1= 25%= 1/4 x 10000 = 2500, m2= 7500 , m3= 20%= .2 x 7500 = 1500

So m = $(2500 + 7500 -1500) = $ 8500

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