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The monetary base is 2,500 dollars. People hold one-third of the currency in monetary terms (two-thirds as bank deposits). The reserve-deposit ratio (rr) of banks is 1/4. What is the money supply?

Question

The monetary base is 2,500 dollars. People hold one-third of the currency in monetary terms (two-thirds as bank deposits). The reserve-deposit ratio (rr) of banks is 1/4. What is the money supply?

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Solution

To calculate the money supply, we need to use the formula for the money multiplier and then multiply it by the monetary base.

The money multiplier formula is 1 + (Currency-Deposit Ratio) / (Currency-Deposit Ratio + Reserve-Deposit Ratio).

Given that people hold one-third of the currency in monetary terms, the Currency-Deposit Ratio is 1/2.

The Reserve-Deposit Ratio is given as 1/4.

So, the money multiplier is 1 + (1/2) / (1/2 + 1/4) = 1 + 2/3 = 5/3 = 1.67 (approximately).

Now, multiply the money multiplier by the monetary base to get the money supply.

Money Supply = Money Multiplier * Monetary Base = 1.67 * 2,500 = 4,175 dollars.

So, the money supply is approximately 4,175 dollars.

This problem has been solved

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