Suppose a person deposits \$1,000 in cash into a checking account at a commercial bank. If the required reserve ratio is 10%, what is the maximum possible increase in the M1 money supply resulting from this deposit?

• A. \$1,000
• B. \$9,000
• C. \$10,000
• D. \$100

Answer: (B)

Verified step by step guidance

1. Identify the key variables: the initial deposit amount (\$1,000) and the required reserve ratio (10%, or 0.10).
2. Recall that the required reserve ratio (RRR) is the fraction of deposits that banks must hold as reserves and cannot loan out. The rest can be loaned, which creates new money.
3. Calculate the money multiplier using the formula: \(\text{Money Multiplier} = \frac{1}{\text{Required Reserve Ratio}} = \frac{1}{0.10}\).
4. Determine the maximum potential increase in the money supply by multiplying the initial deposit by the money multiplier: \(\text{Maximum Increase} = \text{Initial Deposit} \times \text{Money Multiplier}\).
5. Interpret the result as the total increase in M1 money supply, which includes the original deposit plus the new money created through the lending process.