Suppose that you take $50 in currency out of your pocket and deposit it in your checking account. If the required reserve ratio is 8%, what is the largest amount (in dollars) by which the money supply can increase as a result of your action?

The largest amount (in dollars) by which the money supply can increase as a result of the action is $625.

Explanation:

This is an example of money multiplier.

Money multiplier refers to the maximum amount of money that commercial bank can create or generate with each dollar of reserves.

Reserves or required reserves refer to the amount of money or portion of deposit that the central bank such as the Federal Reserve requires banks to hold and not lend.

In order to determine the largest amount (in dollars) by which the money supply can increase as a result of $50 deposit, money multiplier is used to multiply the $50 deposit.

The formula for the money multiplier is given as follows:

Money multiplier = 1/r

Where;

r = required reserve ratio = 8%, or 0.08.

Therefore, we have:

Money multiplier = 1 / 0.08 = 12.50

Largest amount of increase = Amount of deposit * Money multiplier = $50 * 12.50 = $625.

Therefore, the largest amount (in dollars) by which the money supply can increase as a result of the action is $625.

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