If the monetary base of a country is $7,000. People hold half of their money in the form of currency, and commercial banks hold a quarter of their deposits in reserve. Context: long run, closed economy (a)Compute the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply.
Question
If the monetary base of a country is $7,000. People hold half of their money in the form of currency, and commercial banks hold a quarter of their deposits in reserve. Context: long run, closed economy
(a)Compute the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply.
Solution
(a) To compute the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply, follow these steps:
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Reserve-Deposit Ratio: This is the proportion of the total deposits that the bank holds as reserves. In this case, it's given that commercial banks hold a quarter of their deposits in reserve. Therefore, the reserve-deposit ratio is 0.25 or 25%.
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Currency-Deposit Ratio: This is the proportion of the total money that people hold in the form of currency. In this case, it's given that people hold half of their money in the form of currency. Therefore, the currency-deposit ratio is 0.5 or 50%.
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Money Multiplier: The money multiplier is calculated using the formula: Money Multiplier = 1 + Currency-Deposit Ratio / Reserve-Deposit Ratio + Currency-Deposit Ratio Substituting the given values into the formula, we get: Money Multiplier = 1 + 0.5 / 0.25 + 0.5 = 3
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Money Supply: The money supply is calculated by multiplying the monetary base by the money multiplier. In this case, it's given that the monetary base of the country is 7,000 * 3 = $21,000
So, the reserve-deposit ratio is 25%, the currency-deposit ratio is 50%, the money multiplier is 3, and the money supply is $21,000.
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