Question

1. Assume initially that Never Bank is the only bank in Neverland. State the effects on money supply if Never Bank decides not to make any loans. Compare this to the effect on money supply if, alternatively, Never Bank decides to loan out all its available deposits for loans. (compare both the scenarios in 150 words or less).

Answer 1

Answer)

Money supply refers to the total amount of money that is there in the circulation in an economy in the form of cash, currency, deposits , gold ,savings etc.

As, we are given 2 scenarios, so , we would discuss them in detail as follows:

(i) Never Bank does not make any loan:

If the bank does not make any loans, then it means that it keeps all the deposited money of the customers with itself in its reserves.It means that now there is no further circulation of the money in the economy after a customer deposits it in the bank.This would ultimately lead to decrease in the money supply as loan making capacity of a bank is positively related to the money supply in an economy.For example, $100 is submitted in the bank , but the bank does not circulate it further in the form of loans, then the money supply gets halted.

(ii) Never Bank makes the loan:

When the Never bank makes the loan, then it means that an extra amount of money is going into someone's hand and it keeps circulating in the economy as each individual further conducts a transaction in some form.As, we know that there is positive relationship between the loan making and money supply, so, we can say that the money supply would increase as the Never bank makes the loans of the deposits that it receives.