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Posted 3 months ago

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The central bank in Hamsterville has bought $\$ 100$ in bonds from a bank. The reserve requirement is $25 \%$.
What is the maximum possible change in the money supply?
Choose 1 answer:
(A) The money supply increases by $\$ 200$
(B) The money supply increases by $\$ 400$.
(C) The money supply increases by $\$ 100$
(D) The money supply decreases by $\$ 400$.
(E) The money supply decreases by $\$ 100$
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Answer from Sia

Posted 3 months ago

Solution by Steps

step 1

To determine the maximum possible change in the money supply, we need to use the money multiplier formula. The money multiplier is given by $\frac{1}{\text{reserve requirement}}$

step 2

The reserve requirement is 25%, or 0.25. Therefore, the money multiplier is $\frac{1}{0.25} = 4$

step 3

The central bank has bought $100 in bonds. The maximum possible change in the money supply is the product of the money multiplier and the amount of bonds bought: \( 4 \times 100 = 400 \)

Answer

B

Key Concept

Money Multiplier

Explanation

The money multiplier effect shows how an initial change in the money supply can lead to a larger change in the total money supply. In this case, a reserve requirement of 25% results in a money multiplier of 4, leading to a maximum possible increase in the money supply of $400 when the central bank buys$100 in bonds.

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