Question

The economy of the Village of Pantherville contains 50,000 $1 bills. [Briefly explain how you arrived at each of your answers.]

a) If people in Pantherville hold all money as currency, what is the quantity of money?

b) If people hold all money as demand deposits and the Bank of Pantherville maintains 100% reserves, what is the quantity of money?

c) If people hold equal amounts of currency and demand deposits and the Bank of Pantherville maintains 100% reserves, what is the quantity of money?

d) If people hold all money as demand deposits and the Bank of Pantherville maintains a reserve ratio of 10%, what is the maximum quantity of money? [Hint: What is the money multiplier with a reserve ratio of .1?]

e) If people hold equal amounts of currency and demand deposits and the Bank of Pantherville maintains a reserve ratio of 10%, what is the qualtity of money? [This is more challenging, but some simple algebra can be of assistance.  Consider the following equations:

            1) M = C + D (quantity of money equals currency + deposits)

            2) C = D (currency must equal demand deposits)

            3) 10*($50,000 - C) = D (total demand deposits equals the money multiplier times available reserves. In this instance total available reserves are (50,000 - currency holdings)

            Substitute (3) into (2) and solve for C

            Then once you have C, you can solve for M given that C must equal D.]

Answer 1

The economy of the Village of Pantherville contains 50,000 $1 bills.

a) If people in Pantherville hold all money as currency, the quantity of money will only have currency in circulation which is $50000.

b) If people hold all money as demand deposits and the Bank of Pantherville maintains 100% reserves, there are no loans made and so again the quantity of money is $50000.

c) If people hold equal amounts of currency and demand deposits and the Bank of Pantherville maintains 100% reserves, then currency in circulation is 25000 and deposits are 25000 making C-D ratio = 1 and so multiplier is

mm = (1 + 100%)/(100% + 100%) (use mm = (1 + C-D ratio / reserve ratio + C-D ratio)

= 1

Again the quantity of money = $50000. (Use money supply = multiplier x monetary base where monetary base = currency + reserves),

d) If people hold all money as demand deposits and the Bank of Pantherville maintains a reserve ratio of 10%, then C-D ratio = 0 and R-D ratio = 10%. Hence we have multiplier = 1/10% = 10. Monetary base = reserves = 50000. Hence money supply = 50000*10 = $500,000.

e) If people hold equal amounts of currency and demand deposits so that C-D ratio is 100% and the Bank of Pantherville maintains a reserve ratio of 10%, so that R-D ratio is 10%, multiplier = (1 + 100%)/(100% + 10%) = 1.818. Hence the qualtity of money = 1.818*50000 (money multiplier x monetary base)

= $90910