If a bank uses $500 of excess reserves to make a new loan when the reserve ratio is 8 percent,this action by itself initially makes the money supply
A)and wealth increase by $500.
B)and wealth decrease by $500.
C)increase by $500 while wealth does not change.
D)decrease by $500 while wealth decreases by $500.

Question

Quizplus · Accepted Answer

When a bank uses excess reserves to make a new loan, the money supply increases by an amount determined by the money multiplier, which is 1/required reserve ratio. In this case, the required reserve ratio is 8 percent, so the money multiplier is 1/0.08 = 12.5. Therefore, the initial increase in the money supply is 12.5 times the amount of excess reserves used, or $6,250 ($500 x 12.5). Wealth does not change because although the bank's assets (loans) increase, its liabilities (deposits) also increase by the same amount.

If a Bank Uses $500 of Excess Reserves to Make