Question 1 on a combination of topics 6 and 9 (20 marks)

a.Assume that the reserve ratio in a country is 2%.

(i)Use a formula to calculate the simple money multiplier, show all steps involved in the calculation. (2 marks)

(ii)Suppose that in 2019 customers deposit $200 into their banks. Based on the simple money multiplier calculated in part (i), calculate the total amount which the money supply in the banking system will eventually increase to. Show all steps involved in the calculation.(2 marks)

(iii)Assume the amount of funds deposited by customers in 2020 stands at $400. and the reserve ratio increases to 8%. Will the money supply in the banking system increase, decrease or stay the same from 2019 levels? If it increases or decreases, calculate by how much it will change. If it stays the same, explain why. Show all steps involved in any calculations. (6 marks)

b.Inflation in the country of Hypothetica is currently 5%, above the target range of its central bank.

(i)What does this tell you regarding Hypothetica's likely output gap? Illustrate it using an AS-AD diagram, and briefly explain your diagram(6 marks)

(ii)In this situation, what is the central bank likely to do with regard to monetary policy? Briefly explain your answer and state also what is likely to occur to the price level and output at the end of this process (there is no need to draw a diagram, but you can if you feel it helps you explain your answer) (2 marks)

What happens if the central bank does not intervene? Will the economy eventually return to long-run equilibrium (potential GDP)? Briefly explain your answer and state also what is likely to occur to the price level and output at the end of this process (there is no need to draw a diagram, but you can if you feel it helps you explain your answer).