how can a loan for school tuition affect the money supply? how can it affect aggregate demand?
A loan, taken out of some cash reserve, would increase the money supply. The amount of the increase would be determined by the money-multiplier. The increase in spending (in this example on school tuition) is itself an increase in aggregate demand. This increase has ripple effects, aggregate spending rising by a multipler process.
To understand how a loan for school tuition can affect the money supply and aggregate demand, let's break it down step by step:
1. Loan and Money Supply: When a loan is taken out for school tuition, it typically involves a lender providing funds to the borrower. This loan increases the money supply in the economy. How does this happen?
2. Money Multiplier: The money supply increase resulting from a loan depends on the money multiplier. The money multiplier is the ratio of the total amount of money that can be created through the fractional reserve banking system. When a loan is made, banks are required to hold only a fraction (reserve ratio) of that loan as reserves and can loan out the rest. This process continues through the banking system, where each bank becomes a lender and borrower, effectively creating new money.
3. Increase in Aggregate Demand: Once the loan is issued, the borrower can use the funds to pay for their school tuition. This increased spending on education is considered a component of aggregate demand, specifically under the category of consumption expenditure.
4. Ripple Effects and Aggregate Spending: The increase in aggregate demand caused by the loan for school tuition has ripple effects through the economy. When students pay for their education, the educational institutions receive the money and can then use it to pay their employees, purchase supplies, and invest in resources. This, in turn, increases the income and spending power of the employees and suppliers, who can then spend on other goods and services, creating a multiplier effect on aggregate demand.
In summary, a loan for school tuition increases the money supply through the process of fractional reserve banking. This increase in the money supply leads to an increase in aggregate demand, as the borrowed funds are spent on education. The subsequent spending by educational institutions and the individuals involved creates a multiplier effect, further boosting aggregate demand in the economy.