Question

The reserve requirement is 10% and Jack withdraws $5,000 travel money from his checkable deposit. Assume that banks do not hold any excess reserves and that the public holds no currency, only checkable bank deposits. By how much will the money supply contract as a result of the withdrawal?

Answer 1

Answer:

decrease by 50,000 dollars

Explanation:

As the required reserve ratio is 10% we can determinate that the multiplier for the money supply is:

1 / 0.1 = 10

Each dollar deposit increase the money supply by 10 and each dollar withdraw decrease it by 10

This is due to the following reasoniing:

once a person deposit the bank keep the minimum and lend the rest. Then that ends up in another person how also deposit and again the process is repeated, the bank keeps the 10% and loans the 90% and so on until it finds a limit in the above formula.

Now, a 5,000 withdrawals will generate a 50,000 decreasei nthe money supply