If the required reserve ratio is 12% and total reserves increase by $100, what is the maximum amount by which the money supply can expand?
The reserve ratio is the amount that a bank is required to keep. If the required reserve s 10% and the bank had $1,000 in assets the bank would be required to keep $100 in reserves and could lend 90%. With that as the background you should now able to answer the question that you asked.
To determine the maximum amount by which the money supply can expand, we need to use the concept of the money multiplier, which is based on the required reserve ratio. The money multiplier represents how much the money supply can increase as a result of a change in reserves.
The required reserve ratio is the percentage of deposits that banks are required to hold in reserves. In this case, the required reserve ratio is 12%. This means that banks must hold 12% of their deposits as reserves and can loan out the remaining 88% of the deposits.
Now, let's calculate the money multiplier using the formula:
Money Multiplier = 1 / Required Reserve Ratio
In this case, the required reserve ratio is 12%, so the money multiplier would be:
Money Multiplier = 1 / 0.12 = 8.33
The money multiplier of 8.33 indicates that for every $1 increase in reserves, the money supply can expand by $8.33.
Given that total reserves increased by $100, we can calculate the maximum amount by which the money supply can expand by multiplying the increase in reserves by the money multiplier:
Maximum Expansion = Increase in Reserves * Money Multiplier
= $100 * 8.33
= $833
Therefore, the maximum amount by which the money supply can expand is $833.