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 the properties of the profit function, What are the properties of ...

What are the properties of the profit function? Properties of the Profit Function: The properties specified below follow solely by the assumption of profit maximization. No

Bank Balance sheet, I need help with filling out the bank balance sheet.

I need help with filling out the bank balance sheet.

Cross price , Calculate the cross-price elasticity of demand between comput...

Calculate the cross-price elasticity of demand between computers and printers, where a 10 percent decrease in the price of computers results in a 15 percent increase in the quantit

Monopsony, Monopsony: Demonstrate (with a graph) how a ...

Monopsony: Demonstrate (with a graph) how a minimum wage can increase both the wage and employment in a monopsony market even when the government sets th

Utility, how do I calculate for utility

how do I calculate for utility

Consumer and producer surplus, Suppose that demand is downward sloping and ...

Suppose that demand is downward sloping and supply upward sloping. Subsidies cause dead weight loss despite the fact that: 1)consumer surplus increases. 2)total surplus increases

Functions and resources of the world bank, Functions and Resources of the B...

Functions and Resources of the Bank  The main functions of the Bank are as follows: •  to assist in reconstruction and development of the territories of it member-governmen

The great depression, How did fixed exchange rates and the Golden Standard ...

How did fixed exchange rates and the Golden Standard affect the U.S. economy as well as other countries.

Define solvency margin, In relation to solvency margins in the insurance in...

In relation to solvency margins in the insurance industry, the solvency margin is the amount of regulatory capital an insurance undertaking is obliged to hold against unforeseen ev

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