Question

If reserves are scarce, how would the money supply M change (increase or decrease) and why (due to an increase, decrease, or no change in the monetary base B, in the reserve-deposit ratio rr, or in the currency-deposit ratio cr) if:

a) an article reporting a significant surge in cases involving counterfeit currency becomes viral.

b) all drugs are legalized.

Just analyze in these two situations how would money supply change. The question is complete, if you can't give answer please don't write comments!

Answer 1

Let us see the answer to the question as below with important aspects involved.

Basically to understand:
1.   Monetary sector consist of all the organizations, institutions and agents that deal in monetary transactions, i.e. borrowing and lending. It includes central banks, commercial banks, financial institutions and monetary dealers.
2.   In general money can be defined as any commodity and monetary documents that is generally acceptable as a medium of exchange and store of value.

In the given situations, money supply is measured as under two concepts of money supply, i.e. ordinary money and high power money. Under the concept of of ordinary money, money is measured as M = C +DD, where C= currency with public and DD = demand deposits with banks. Under the concept of high power money (H), money supply is measured as H = C + R, where C= currency with public and R = cash reserves with central bank

The supply of and demand for money are the two important variables of the monetary sector. Money supply and demand determine two important macro economic variables, i.e. the rate of interest (return of money) and general price level.

The demand for money by the people arises for three motives, i.e. transaction motive, precautionary motive and speculative motive.

Both money demand and supply are subject to change, increase or decrease over a period of time. The change in money demand and supply causes change in the interest rate. For example, given the supply of money, increase in demand for money causes increase in the interest rate and vice versa. Similarly, given the money demand, increase in money supply leads to decrease in the interest rate and vice versa.

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