How to get Money Multiplier?
Accordingly, the money supply, high-powered money (H) is the reserve ratio (RRr) prescribed by the central bank. It is known that excess reserve ratio (XRr) of commercial banks depends on currency held by the public and demand deposit ratio (C). Some of these depend on the behavior of the central bank, some on the behavior of commercial banks, and some on the behavior of the public. Let us propose an equation that tells how the behavior of the central bank, the behavior of the commercial banks, and the behavior of the people together determine the money supply and through it let us find out how each of the determinants of the money supply has a relationship with the money supply.
To propose the money supply equation, money supply must be defined. We know that money supply is defined in different ways. We now propose a money supply equation following the traditional approach to defining money supply.
Money supply=Ms
Currency with Public= C
Demand deposits of commercial banks= D
Ms=C+D ..................(1)
High powered money=H
Reserves of commercial banks=R then
H= C+R ......................(2)
2 nd equation divided by Ms
H/Ms+R/Ms ..........................(3}
Last fraction of 3rd equation can be written as
R/Ms= R/D-R/D÷RMs ............................(4)
Second term of right side in 4th equation multiplied with Ms/Ms and 3rd term multiplied with D/D
R/Ms = R/D-R/D×Ms/Ms+ R/Ms×D/D
= R/D - R(Ms-D)/D.Ms .................(5)
According to equation 1, Ms-D=C and Substitute Ms-D value in equation 5
R/Ms= R/D - C/Ms×R/D. ........................ (6)
Substitute the value of R/Ms in equation 3
H/Ms=(C/Ms+R/D) - (C/Ms×R/D) .........................(7)
Ms/H= 1÷{(C/Ms+R/D) - (C/Ms× R/D)} ...............(8) ( Inverse of equation 7)
Ms= H÷ {(C/Ms +R/D) - ( C/Ms × R/D)} ............................ (9)
Write C/M as Cr and R/D as Rr in equation (9)
MS = H÷ {( Cr+ Rr) - (Cr×Rr)} ..................... (10)
Commercial banks have a policy of holding excess reserves, the amount of excess reserves is XR. The amount of reserves to be maintained as prescribed by the Central Bank is RR. But the amount of reserves of commercial banks, R, is the sum of these two.
i.e. R = XR +RR ........,..............(11)
Equation 11 divided by D
R/D = XR/D+ RR/D
i.e. Rr = XRr + RRr ..............(12)
The value of Rr from 12 substitute in equation 10
Ms = H÷ ( Cr + XRr + RRr)-Cr(XRr + RRr) ....................(13)
Examining Equation 13, the money supply is inversely related to the leverage H and the currency ratio Cr. The excess reserve ratio is XRr. Reserve ratio prescribed by Central Bank is also known to be closely related to RR. H and RRr in water are determined by the central bank. So the amount of water depends on the behavior of the central bank. The size of excess reserve ratio XRr depends on the behavior of commercial banks. So it can be said that the behavior of the central bank, the behavior of the people and the behavior of the commercial banks together determine the supply.
Equation 13 can be written as
Ms= [1÷( Cr + XRr + RRr) - Cr(XRr + RRr)] H ............(14)
currency ratio and the Reserve of Commerce Banks, Nothing in the Reserve proportions set forth of the Central Bank, is a changing in the High powered money money ∆H then supply of Money also changes ∆M.
∆M = [ 1÷ ( Cr + XRr + RRr) - Cr(XRr + RRr)] ∆H
∆Ms/ ∆H = [1/(Cr + XRr+ RRr) - Cr(XRr - RRr)] ............ (15) This is Money Multiplier.
2. In an Economy Autonomous investment (Ia) equals Rs. 1000 Crores and consumption function is C= 500+0.4Y. Find the equilibrium level of Income.
Solution:
Y= C+Ia
C= 500+0.4Y
Ia= 1000 Crores
Formula for equilibrium level of Income in an Economy:
Y= 1/(1-b){a+Ia}
According to given problem:
MPC(b)= 0.4=4/10=2/5
a=500
Ia=1000
Substitute above values in formula:
Y=1/1-b[a+Ia]
Y=1/1-2/5[500+1000]
Y=1÷(5-2)/5)[1500]
Y=1÷3/5[1500]
Y=1×5/3[1500]
Y=5/3[1500]
Y= 5×500
Y=2500 Crores
Equilibrium level of Income in an Economy is 2500 Crores
3. When AR is falling MR wil be
A. Equal o AR
B. Less than AR✓
More than AR
Either More or equal to AR
4. Th Revelled preference Theory was formulated by...
A. Alfred Marshall
B. Joan Robinson
C. Lionel Robbins
D. Paul Samuelson✓
5. Consumer 's surplus is the highest in the case of ...
A.comforts
B. Necessities✓
C. Luxuries
D. Conventional necessities
6. When average product increases, the marginal product is...
A. More than the average product
B. Less than the average product✓
C. Equal to the average product
D. None of the above
7. The average profit is equal to the difference between....
A. AC and VC
B. AC and TC
C. AC and AR✓
D.AC and TR
8. Substitution effect is always...
A. Positive✓
B. Negative
C. Positive & Negative both
D. Equal to income Effect
9. For the equilibrium level employment of a factor of production the necessary condition is ...
A. ARP = AFC
B. MRP = ARP
C. MRP = MFC✓
D. MR = VMP
10. The total utility is maximum at a point , then marginal utility is ...
A. Negative
B. Positive
C. Zero✓
D. Positive but decreasing
11. The concept of 'Learning by doing' was given by...
A. Kenneth Arrow✓
B. J.R. Hicks
C. John Robinson
D. Marshall
12. Given the consumption function, C= 0.8Y, and the investment function I = 102. - 0.2i, then the IS curve is ...( UGC net June 2014)
A. Y=450 - i
B. Y= 510 - i✓
C. Y = 500 - 10i
D. Y= 505 - 2i
Solution: S = I
102 - 0.2i = 0.2Y
= 0.2Y = 102 - 0.2i
Y =(102 - 0.2i)/0.2
= 102/0.2- 0.2i/0.2
510 - i
