2016 AP Macroeconomics FRQ #2
Nothing in this world is free, and that if you want something out of life you've got to work to get it
(A) What is the dollar value of new loans that First Superior Bank can make? Explain.
Demand deposits = amount of money deposited into the bank.
If $2,000 dollars has been deposited into the bank the bank must keep 10% of it in reserve. So, $200 must be kept in the bank in reserve as that is required by the FED, (Federal Reserve). Then the bank loaned out $1,800 to some other customer.
So if the bank has to hold in reserve $200 and loans out $1,800 then that $2000 is not able to be loaned out to anyone else. The bank has no excess reserves to loan.
If Mr. Smith deposits $100 of cash 10% of it must be held in reserve.(As the FED requires) So 10% of $100 is $10 and $100 - $10 = $90. Therefore $90 is the maximum amount of new loans that can be made, (Loaned Out).
(C) As a result of Mr. Smith's $100 cash deposit, calculate the maximum change over time in each of the following banking system.
If Mr. Smith deposits $100 in the bank and $10 is kept in reserves then $90 can be loaned out. If that $90 is deposited in another bank then 10% of the $90 or $9 must be kept in reserve and therefore $81 can then be loaned out in the next round and 10% of that must be kept in reserve and so on and so on and so on. Until all is loaned out.
The quick way to figure this out is to understand that the formula for this is the Required Reserve Ratio or 1/RR, so, 1/10% or 1/.1 which will equal 10.
Answer - $90 x 10 = $900
(ii) Demand Deposits.
The maximum amount of demand deposits in the banking system due to Mr. Smith's $100 deposit is $100 x 10 = $1,000.
(D) As a result of Mr. Smith's $100 deposit, calculate the maximum change over time in the money supply.
The original $100 was already part of the money supply so you can't include that in the calculation.
(E) Provide one reason why the actual change in the money supply can be smaller than the maximum change you identified in part (D).
If credit card rates increase (past AP question) then people will be inclined to hold more cash and this will decrease the effects of the money multiplier.
If banks voluntarily hold excess reserves then the money multiplier will have less of an effect on the money supply.
(Not entirely happy with my explanations for this section, stay tuned for a more thorough explanation.)