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

What are possible negative consequences of economic growth, What are the po...

What are the possible negative consequences of economic growth in a developing country? Define economic growth as an enhance in GDP during a given time period, and then define

Potential Pareto Improvement, I need some help to answer a discussion topic...

I need some help to answer a discussion topic question about Potential Pareto Improvement, based on an article

Choose a topic from microeconomics ., choose a topic from microeconomics th...

choose a topic from microeconomics that matters to you and find a recent news article covering that topic?

World trade organisation, WORLD TRADE ORGANISATION (WTO): The Internat...

WORLD TRADE ORGANISATION (WTO): The International Trade Organisation (ITO), originally, was proposed to be set up along with the World Bank and the IMF on the recommendations

Economic system, what is the definition of economic system?

what is the definition of economic system?

Bains model of limit pricing., explain diagrammatically the bains model of ...

explain diagrammatically the bains model of limit pricing.

What is the benefit from the existence of monopolies, Explain how consumers...

Explain how consumers might benefit from the existence of monopolies. While the standard issue of monopolies having higher prices and lower output that competitive markets migh

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