Suppose the reserve ratio is 25 percent and the public holds $10 million in cash. Then the public decides to withdraw $5 million from the banks. How does the money supply eventually change?
A) falls by $5 million
B) falls by $10 million
C) falls by $20 million
D) falls by $35 million

Question

Quizplus · Accepted Answer

The reserve ratio is 25%, meaning banks must keep 25% of deposits as reserves. When $5 million is withdrawn, banks lose $5 million in deposits, reducing their ability to create money. The money multiplier is 1/0.25 = 4. The $5 million withdrawal reduces the money supply by $5 million x 4 = $20 million.

Suppose the Reserve Ratio Is 25 Percent and the Public