a. The initial money supply is $1,000, of which $500 is currency held by the public. The desired reserve-deposit ratio is 0.2. Find the increase in money supply associated with increases in bank reserves of $1, $5, and $10. What is the money multiplier in the economy?

(1) $5

(2) $25

(3) $50

Money multiplier = 5 times

Explanation:

Initial bank reserves:

= Desired Reserve-deposit ratio * Currency held by public

= 0.2 * $500

= $100

(1) Increase in bank reserves by $1, so

Bank reserve deposit increases from $500 to:

= (Initial bank reserves + $1) : Desired Reserve-deposit ratio

= $101 : 0.2

= $505

Money supply increases by:

= New bank reserve deposit - Currency held by public

= $505 - $500

= $5

(2) Increase in bank reserves by $5, so

Bank reserve deposit increases from $500 to:

= (Initial bank reserves + $5) : Desired Reserve-deposit ratio

= $105 : 0.2

= $525

Money supply increases by:

= New bank reserve deposit - Currency held by public

= $525 - $500

= $25

(3) Increase in bank reserves by $10, so

Bank reserve deposit increases from $500 to:

= (Initial bank reserves + $10) : Desired Reserve-deposit ratio

= $110 : 0.2

= $550

Money supply increases by:

= New bank reserve deposit - Currency held by public

= $550 - $500

= $5 0

Money multiplier = 1 : Desired Reserve-deposit ratio

= 1 : 0.2

= 5 times