The Fed makes an open market operation purchase of $200,000.The currency drain ratio is 33.33 percent and the desired reserve ratio is 10 percent.By how much does the quantity of money increase?
A)$800,000
B)$333,333
C)$2,000,000
D)$615,416
E)$465,116

Question

Quizplus · Accepted Answer

To calculate the change in the quantity of money, we need to apply the following formula:

Change in Quantity of Money = Change in Reserves / Desired Reserve Ratio

First, let's calculate the change in reserves:

Open Market Operation Purchase = $200,000
Currency Drain Ratio = 33.33%

Currency Drain = Open Market Operation Purchase × Currency Drain Ratio
Currency Drain = $200,000 × 33.33% = $66,660

Change in Reserves = Open Market Operation Purchase - Currency Drain
Change in Reserves = $200,000 - $66,660 = $133,340

Now, let's calculate the change in the quantity of money:

Desired Reserve Ratio = 10%

Change in Quantity of Money = Change in Reserves / Desired Reserve Ratio
Change in Quantity of Money = $133,340 / 10%
Change in Quantity of Money = $1,333,400

Therefore, the quantity of money increases by $1,333,400 or approximately $615,416 once we subtract the lost reserves due to the currency drain.

The correct answer is: 
D) $615,416

The Fed Makes an Open Market Operation Purchase of $200,000