Question

With a required reserve ratio of 20%, explain in detail how an Open Market Purchase of $100,000 from an individual leads to an expansion in the money supply. I would like you to describe (at least) four different "rounds" in this process. By how much does the money supply increase during each round? What is the maximum the money supply can increase from this Open Market Purchase? What can lead to the actual increase being much lower than the above number?

Answer 1

Answer:

the answer is 500000

Explanation:

Solution

When bank gives out loan they don't reimburse them in cash rather they pit in amount into their demand deposit and deposit  is also part of supply of money.

Normally, let's  say bank give loan of 100000 to a first person.then bank will give the person 1 with the deposit demand in his account. based on requirements reserve ratio, the  bank will keep 20% with them in cash and borrow the  remaining 80000 to other person.

Again, the bank will deposit in person 2 or second person and lend 64000 o third person  and keep 16000 as cash.

Importantly, in the explanation above when we say bank will deposit 80000 in persons account,its only refers to as book keeping, that is, it is written only in books and the account holder balance goes higher but the actual money stays with the bank.

Now,

Total amount of money supply bank can produce = the multiplier*high money powered =1/0.2*100000

=500000