1. Assume the reserve requirement is 20% and banks hold no excess reserves.

a) Assume that Mrs. Lafarge deposits $500 of cash from her pocket into a checking account at

the First Bank of Swindletown. Calculate each of the following. Be sure to show your math.

i) The maximum dollar amount the First Bank of Swindletown can initially lend.

ii) The maximum amount of new demand deposits in the entire banking system.

iii) The maximum change in the money supply.

b) Assume the Federal Reserve Bank (Central Bank) buys $5Million in government bonds on

the open market. As a result of this purchase, calculate the maximum increase in the money

supply for the banking system.

c) What are two reasons that the money supply will not increase by as much as the multiplier

effect states it will in the banking system.