Money creation process, Microeconomics

Assignment Help:

The Money Creation Process is explained below:

We can now study the money supply or the creation process. Suppose the government wishes to buy pencils worth Rs. 10 for the officials working for it. The supplier firm is called S and has the deposit account with Bank A. In order to buy the pencil, the government asks the central bank to print the 10 rupee note and give it to government.5 this action makes M0 to expand by Rs. 10. Now the government gives this amount to S (in exchange for the pencils) who in turn deposits the sum of money into his account in Bank A. What is the work of A? Assuming it operates the safety cushion or reserve ratio of 10%, A will add Re 1 to its liquidity reserve and then lend Rs 9 to the firm T. Firm T, takes the Rs 9 and deposits it in an another Bank B. B acts in the similar way: it adds 90 paisa (10% of Rs 9) to its existing liquidity reserve and lends the remaining amount which is Rs 8.1 to firm Z. The process goes carries on, the amount lent falling every time by the factor of 10%.

If the money creation process is made as an infinite series (starting from central bank printing   ten   rupee   note),   we   will   get   10   +   10*(90%)   +   10*(90%)*(90%)  + 10*(90%)*(90%)*(90%) + ……. which is an infinite converging series with the first term of 10 and a convergence factor of 0.9 (or 90%). The sum till infinity of this series is 10/(1-0.9) = 100. Therefore, an initial M0 expansion of Rs. 10 has a entire money supply (or M2) impact of Rs 100, thanks to the intermediation of the commercial banks. There is a money multiplier (MM) at action of magnitude 10.


Related Discussions:- Money creation process

Easy, what are the factors influencing supply

what are the factors influencing supply

Analysing the digital economy relative to e business, Problem: a) What ...

Problem: a) What factors would you consider when analysing the digital economy relative to e business? b) "The growing use of the internet by consumers and businesses has re

Coefficient of price elasticity, A local airline charges $500 to fly (round...

A local airline charges $500 to fly (round-trip) to Louisville, Kentucky. From the past three months, whereas the $500 fare has been in effect every of the two daily flights have a

Majority minority, Are there any economic effects to non-Hispanic whites, g...

Are there any economic effects to non-Hispanic whites, given that they no longer represent the majority of the population? Why are these examples important from an economic standpo

Enzyme activity mechanism, The enzymes are highly specific in nature. Durin...

The enzymes are highly specific in nature. During enzymatic reaction the enzyme is so built that it binds to the substrate in a specific manner. The stepwise mechanism of enzyme ca

Dalton''s law of partial pressures, Describe Dalton''s law of partial press...

Describe Dalton''s law of partial pressures, specification of Dalton''s law of partial pressures, Dalton''s law states that, at a given known temperature total pressure exerted b

OLIGOPLOLY MODELS, GIVE EXAMPLES OF EACH OLIGOPOLY MODELS FROM REAL LIFE

GIVE EXAMPLES OF EACH OLIGOPOLY MODELS FROM REAL LIFE

Types of budget, Types of budget: Surplus Budget: A surplus budget o...

Types of budget: Surplus Budget: A surplus budget occurs when the expected government revenue is planned to exceed the proposed government expenditure. It can be achieved by

Proportion of income spent for the commodity , All other things equivalent,...

All other things equivalent, the higher the proportion of income spent for the commodity more price elastic will be the demand.   Most home owners are recognizable with how this de

Policy implications - structure of national income , Policy Implications: ...

Policy Implications: The expansion of the services sector  has wider implications for population, employment, and trade prospects of the economy, some of which are as follows:

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd