# Chapter 23. Question 15

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Question 15
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You must read each slide, and complete any questions on the slide, in sequence.

Assume that First Purity Bank begins with the balance sheet below and is fully loaned-up.

 First Purity Bank Assets Liabilities Reserves \$700,000 Deposits \$2,000,000 Loans \$1,300,000

### Question

A. What is the reserve requirement? ZDG2fpdWyXw= %
Incorrect! If the bank is fully loaned-up, its reserves are the minimum required. The reserve requirement is equal to reserves divided by deposits. Here, Reserves are \$700,000 and Deposits are \$2,000,000. Dividing these numbers, \$700,000/\$2,000,000 = 0.35 = 35%.
Correct! If the bank is fully loaned-up, its reserves are the minimum required. The reserve requirement is equal to reserves divided by deposits. Here, Reserves are \$700,000 and Deposits are \$2,000,000. Dividing these numbers, \$700,000/\$2,000,000 = 0.35 = 35%.

### Question

B. If the bank receives a new deposit of \$1 million and the bank wants to remain fully loaned-up, how much of this new deposit will the bank loan out? \$ b5luRZx2AOxVr6jO
Incorrect! If First Purity Bank is to remain fully loaned-up, it will keep the minimum possible in reserves, thus loaning out the maximum possible. Multiply the \$1 million new deposit by the reserve requirement, to determine the minimum required to be kept in reserves. Simply, 35% x \$1,000,000 = \$350,000. The remaining \$650,000 can be loaned out.
Correct! If First Purity Bank is to remain fully loaned-up, it will keep the minimum possible in reserves, thus loaning out the maximum possible. Multiply the \$1 million new deposit by the reserve requirement, to determine the minimum required to be kept in reserves. Simply, 35% x \$1,000,000 = \$350,000. The remaining \$650,000 can be loaned out.

### Question

C. What is the potential money multiplier equal to in this case? Express your answer as a decimal rounded to hundredths. 91UpqCq9ubA=
Incorrect! The potential money multiplier equals 1 divided by the reserve requirement. Since the reserve requirement equals 35% or 0.35, 1/0.35 ≈ 2.86.
Correct! The potential money multiplier equals 1 divided by the reserve requirement. Since the reserve requirement equals 35% or 0.35, 1/0.35 ≈ 2.86.

### Question

D. When the new deposit to First Purity Bank works itself through the entire banking system (assume all banks keep fully loaned-up), total deposits will increase by \$ 91UpqCq9ubA= million, total loans increase by \$ Xmjf6cW/z+E= million, and total reserves increase by \$ 0VV1JcqyBrI= million. (Round to nearest hundredth, if necessary.)
Incorrect! As the new deposit works through the banking system, 65% of each deposit will be loaned out again, with the remaining 35% placed into reserves. When First Purity Bank (Bank A) accepts the \$1 million new deposit, it can loan out \$650,000 and will place the remaining \$350,000 into reserves. When the next bank, Bank B, accepts the \$650,000 deposit, it can loan out \$422,500 and must put \$227,500 into reserves. A new deposit of \$422,500 in Bank C will increase its total loans by \$274,625 and total reserves by \$147,875. These numbers become smaller and smaller, eventually approaching zero. In total (more than 50 transactions later), the total money supply will increase by \$2.86 million. Thirty-five percent of this amount, or \$1 million, is in required reserves, while the remaining \$1.86 million is loaned out.
New Deposit x money multiplier = Maximum amount the money supply can increase \$1 million x 2.86 = \$2.86 million maximum possible increase in money supply.
Of this \$2.86 million increase in the money supply, \$1 million was the original new deposit. This means the fractional reserve banking system created \$1.86 million in the form of new loans.
Correct! As the new deposit works through the banking system, 65% of each deposit will be loaned out again, with the remaining 35% placed into reserves. When First Purity Bank (Bank A) accepts the \$1 million new deposit, it can loan out \$650,000 and will place the remaining \$350,000 into reserves. When the next bank, Bank B, accepts the \$650,000 deposit, it can loan out \$422,500 and must put \$227,500 into reserves. A new deposit of \$422,500 in Bank C will increase its total loans by \$274,625 and total reserves by \$147,875. These numbers become smaller and smaller, eventually approaching zero. In total (more than 50 transactions later), the total money supply will increase by \$2.86 million. Thirty-five percent of this amount, or \$1 million, is in required reserves, while the remaining \$1.86 million is loaned out.
New Deposit x money multiplier = Maximum amount the money supply can increase \$1 million x 2.86 = \$2.86 million maximum possible increase in money supply.
Of this \$2.86 million increase in the money supply, \$1 million was the original new deposit. This means the fractional reserve banking system created \$1.86 million in the form of new loans.