Suppose the banking system has $10 million in reserves, the reserve requirement is 20 percent, and there are no excess reserves. The public holds $10 million in cash. Then bankers decide that it is prudent to hold some excess reserves, and so begin to hold 25 percent of deposits in the form of reserves. At the same time, the public decides to withdraw $5 million in currency from the banking system. Other things the same, what will these actions cause the money supply to do?
A)to change forms, but not size
B)to fall by $10 million
C)to fall by $25 million
D)to fall by $35 million

Question

Quizplus · Accepted Answer

Initially, the banking system had $10 million in reserves and the reserve requirement was 20%, so the money supply was $50 million [(reserve requirement of 20% + excess reserves of 0%) / (1 - reserve requirement of 20%) x $10 million in reserves]. 
When bankers decided to hold 25% of deposits as reserves, this reduced the money multiplier to 4 [(reserve requirement of 25% + excess reserves of 0%) / (1 - reserve requirement of 25%)], so the new money supply was $40 million ($10 million in reserves x 4 multiplier). 
When the public withdrew $5 million in currency, this reduced the amount of deposits to $35 million ($40 million - $5 million in withdrawals), so the final money supply was $35 million. Therefore, the money supply fell by $25 million ($50 million - $25 million).

Suppose the Banking System Has $10 Million in Reserves, the Reserve