Suppose that the banking system has excess reserves of $10 million, the desired reserve ratio is 10 percent and the currency drain ratio is 40 percent. By how much will the quantity of money increase?
A)$12.5 million
B)$28 million
C)$50 million
D)$40 million
E)$22 million

Question

Quizplus · Accepted Answer

Excess reserves = $10 million
Desired reserve ratio = 10% = 0.10
Currency drain ratio = 40% = 0.40

Using the formula for calculating the change in the quantity of money:

Change in quantity of money = 1 / (desired reserve ratio + currency drain ratio) * excess reserves

Change in quantity of money = 1 / (0.10 + 0.40) * $10 million
Change in quantity of money = $28 million

Therefore, the quantity of money will increase by $28 million. Option B is the correct answer.

Suppose That the Banking System Has Excess Reserves of $10