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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 decreases by $\$ 400$.
(c) The money supply decreases by $\$ 100$
(D) The money supply increases by $\$ 400$.
(E) The money supply increases by $\$ 100$
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Answer from Sia

Posted 3 months ago

Solution by Steps

step 1

To calculate the maximum possible change in the money supply, we use the money multiplier formula: $Money \, Multiplier = \frac{1}{Reserve \, Requirement}$

step 2

Given the reserve requirement is 25%, we convert this percentage to a decimal to use in the formula: $Reserve \, Requirement = 25\% = 0.25$

step 3

Apply the money multiplier formula with the reserve requirement: $Money \, Multiplier = \frac{1}{0.25} = 4$

step 4

Multiply the initial change in the money supply (the central bank buying $100 in bonds) by the money multiplier to find the maximum possible change in the money supply:$$Maximum \, Change = Money \, Multiplier \times Initial \, Change = 4 \times \$100 = \$400$$

Answer

D

Key Concept

Money Multiplier

Explanation

The money multiplier represents the maximum amount the money supply can increase based on the reserve requirement. It is the inverse of the reserve ratio.

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