Suppose the required reserve ratio is 20 percent,and the Fed buys $1 million worth of bonds from the public.If the public deposits this amount into transactions accounts,the money supply will

Question

Quizplus · Accepted Answer

Since the required reserve ratio is 20%, the Fed's purchase of $1 million worth of bonds increases reserves in the banking system by $1 million x 20% = $200,000. However, since the public deposits the full $1 million into transaction accounts, this increases the money supply by $1 million. 
The lending capacity of the banking system is determined by the money multiplier, which is calculated as 1/reserve requirement. In this case, the reserve requirement is 20%, so the money multiplier is 1/0.2 = 5. Therefore, the additional lending capacity created for the banking system is $1 million x 5 = $5 million. 
So the total increase in the money supply is $1 million + $5 million = $6 million. Therefore, the correct choice is B.

Suppose the Required Reserve Ratio Is 20 Percent,and the Fed