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

Williamson''s managerial discretion., how is price and output equilibrium d...

how is price and output equilibrium determined in Williamson''s model of managerial discretion?

Production posibility curve, what do you understand by production posibilit...

what do you understand by production posibility curve?

Elasticity of demand, elasticity of demand of a product in different market...

elasticity of demand of a product in different market forms such as perfect competition, monoply etc.

Consumer behavior, Consumer Behavior The description of how consumers...

Consumer Behavior The description of how consumers allot their resources (income) to the purchase of various goods and services to get maximum in their well being. There a

Industrial policy, Industrial Policy: Government policies which are aimed a...

Industrial Policy: Government policies which are aimed at fostering the domestic development of particular desirable or productive industries, in order to enhance productivity, cre

Traditional inventory control based on calculation of eoq, Traditional inve...

Traditional inventory control based on the calculation of EOQ   At this point, it is worth considering some of the problems faced by companies using the simple inventory model

TOTAL REVENUE AVERAGE REVENUE AND MARGINAL REVENUE, CASE STUDY IN RELATION ...

CASE STUDY IN RELATION WITH TOTAL REVENUE,AVERAGE REVENUE AND MARGINAL REVENUE

What do you mean by benefits, Q. What do you mean by Benefits? The bene...

Q. What do you mean by Benefits? The benefit of a project, policy or programme is the positive, expected aspect of an outcome, including the improvement in environmental qualit

Labour supply, Discuss how the opportunity cost principle influence a suppl...

Discuss how the opportunity cost principle influence a supplier''s decision to supply labour

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