Suppose Wilma accepts a loan of $10,000 and deposits the money in her checking account. If the required reserve ratio is 20 percent, and if banks loan out all of their reserves, then what is the maximum increase in the money supply after the multiplier effect has fully operated?
A) $2,000.
B) $20,000.
C) $50,000.
D) $45,000.
E) $255,000.

Question

Quizplus · Accepted Answer

The required reserve ratio is 20 percent, so banks are required to keep $2,000 ($10,000 x 0.20) of the $10,000 loan in reserve. This means they can loan out $8,000. When that $8,000 is deposited into another account, the bank must again keep 20 percent in reserves ($1,600) and can loan out $6,400. This process continues until the point where the total increase in the money supply is equal to the initial loan amount divided by the required reserve ratio. So, the maximum increase in the money supply would be:

$10,000 ÷ 0.20 = $50,000

But we need to subtract the initial loan amount to find the net increase, which is:

$50,000 - $10,000 = $40,000

However, the question asks for the maximum increase after the multiplier effect has fully operated, which means the answer is:

$40,000 - $2,000 = $38,000 (since the initial $2,000 kept in reserve counts as part of the money supply)

So, the correct answer is D, $45,000 (the maximum increase in the money supply after the multiplier effect has fully operated).

Suppose Wilma Accepts a Loan of $10,000 and Deposits the Money