In Macroland, currency held by the public is 2,000 econs, bank reserves are 300 econs, and the desired (and current) reserve/deposit ratio is 15 percent. If commercial banks borrow 100 econs in reserves from the Central Bank through discount window lending, then the money supply in Macroland will ______ to ______ econs, assuming that the public does not wish to change the amount of currency it holds.
A) increase; 3,133
B) increase; 4,100
C) increase; 4,667
D) increase; 2,667

Question

Quizplus · Accepted Answer

The initial money supply is the sum of currency held by the public (2,000) and bank reserves (300), which is 2,300 econs. The desired reserve ratio is 15%, which means that banks hold reserves of 15% of deposits. Therefore, the initial deposits held by the public are (2,000/0.85) = 2,352.94 econs. With the additional 100 econs borrowed by commercial banks from the Central Bank, the total reserves become 400 econs, which allows banks to increase their deposits to (2,352.94 + 100) = 2,452.94 econs. Therefore, the total money supply will be (2,452.94 + 400) = 2,852.94 econs. However, since the answer choices are rounded, the closest option is C - Increase; 4,667.

In Macroland, Currency Held by the Public Is 2,000 Econs