Question

The reserve ratio equals 2 percent. The Fed buys $1 million in U.S. government securities. The most the money supply can increase is a. $10 million. b. $40 million. c. $50 million. d. $100 million.

Answer 1

If the Fed buys $1 million in U.S. government securities. The most the money supply can increase is: c. $50 million.

Money supply

Using this formula

Mioney supply=Government securities/Reserve ratio

Where:

Government securities=$1 million

Reserve ratio=2% or 0.02

Let plug in the formula

Money supply=$1 million/0.02

Money supply=$50 million (Increase)

Therefore the most the money supply can increase is: c. $50 million.

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