When the desired reserve ratio is 20 percent,a withdrawal of $500 can ultimately lead to a maximum reduction in the money supply of

Question

Quizplus · Accepted Answer

The desired reserve ratio is 20%, which means that banks are required to hold 20% of their deposits as reserves. This implies that the banks can lend out 80% of their deposits. 
Thus, if a withdrawal of $500 is made, the maximum reduction in the money supply could be calculated as follows:
Initial deposit = $500/0.8 = $625
Reserves required = 20% of $625 = $125
Therefore, the maximum reduction in the money supply would be:
$625 - $125 = $5000 (5*$500)
Hence, the correct answer is C).

When the Desired Reserve Ratio Is 20 Percent,a Withdrawal of $500