Questions: UNIT 3 - CHALLENGE 3.2: Monetary Policy If the reserve requirement of a bank is 25%, then the multiplier effect will be , and 200 in M1 will increase the money supply by . a.) 4 ; 50 b.) 25 ; 50 c.) 25 ; 800 d.) 4 ; 800

UNIT 3 - CHALLENGE 3.2: Monetary Policy If the reserve requirement of a bank is 25%, then the multiplier effect will be , and 200 in M1 will increase the money supply by . a.) 4 ; 50 b.) 25 ; 50 c.) 25 ; 800 d.) 4 ; 800
Transcript text: UNIT 3 - CHALLENGE 3.2: Monetary Policy If the reserve requirement of a bank is $25 \%$, then the multiplier effect will be $\qquad$ , and $\$ 200$ in M1 will increase the money supply by $\qquad$ . a.) $4 ; \$ 50$ b.) $25 ; \$ 50$ c.) $25 ; \$ 800$ d.) $4 ; \$ 800$
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Solution

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Answer

The answer is d.) $4 ; \$800$

Explanation

To solve this problem, we need to understand the concept of the money multiplier and how it affects the money supply.

Option a: $4 ; \$50$
  • Multiplier Calculation: The money multiplier is calculated as the reciprocal of the reserve requirement ratio. If the reserve requirement is 25%, the multiplier is \( \frac{1}{0.25} = 4 \).
  • Money Supply Increase: With a multiplier of 4, an initial increase of $200 in M1 would increase the money supply by \( 200 \times 4 = \$800 \). Therefore, the increase of \$50 is incorrect.
Option b: $25 ; \$50$
  • Multiplier Calculation: A multiplier of 25 would imply a reserve requirement of \( \frac{1}{25} = 4\% \), which is not the case here.
  • Money Supply Increase: The increase of \$50 is incorrect for the reasons explained above.
Option c: $25 ; \$800$
  • Multiplier Calculation: As explained, a multiplier of 25 is incorrect given a 25% reserve requirement.
  • Money Supply Increase: While the \$800 increase is correct, the multiplier is not.
Option d: $4 ; \$800$
  • Multiplier Calculation: With a 25% reserve requirement, the correct multiplier is 4.
  • Money Supply Increase: An initial increase of $200 in M1 would indeed increase the money supply by \( 200 \times 4 = \$800 \).

Thus, the correct answer is option d.) $4 ; \$800$.

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