If the reserve requirement is 25%, then a $500 increase in deposits means that the money supply
A) will increase by $2,000.
B) has the potential to increase by $2,000.
C) will increase by $125.
D) has the potential to increase by $125.

Question

Quizplus · Accepted Answer

If reserve requirement is 25%, then the potential deposit creation multiplier (1/0.25) is 4. 
So a $500 increase in deposits can potentially lead to an increase in money supply by 4 x $500 = $2,000. However, this assumes that all the excess reserves are used for further lending and creating more deposits, which may not always be the case. Therefore, the correct answer is B as the increase in money supply has the potential to be $2,000.

If the Reserve Requirement Is 25%, Then a $500 Increase