Does a lower reserve ratio mean banks can create money freely?

No. Banks may only lend what is left after keeping the required reserve, and the loan must come back as a deposit before it can be lent again. The ratio sets the ceiling, while borrowing and depositing behaviour decides the actual amount.

Why is money supply split into M1, M2 and M3 instead of one total?

Because the assets differ in liquidity. M1 is currency and demand deposits that can pay immediately, while M2 and M3 add savings, time and other deposits, so the split shows immediate purchasing power against potential purchasing power.

S4 Economics: Money and Banking Paper 1 (functions of money, money supply and deposit creation)

2026-11-03

S · 4

This paper starts with the four functions of money, then moves to the layered money supply and deposit creation. Always apply the deposit multiplier of one over the reserve ratio, give answers in billions to the nearest whole number, and every value here is checked by computer.

Quick answer　Medium of exchange, store of value, unit of account, standard of deferred payment; total deposits 5,000 with 4,000 created; M1 is 1,000 billion; multiplier 4; 2,000 billion; M2 is 2,500 billion; from 5,000 down to 4,000; multiplier 4 and money supply 2,400 billion; P equals 2; the error is ignoring the required reserve, so only 800 can be lent.

01　Paper details (check answers afterwards)

Item	Detail
Questions	10 questions
Suggested time	25 minutes
Difficulty mix	Foundation 4 · Intermediate 3 · Challenge 2 · Error redo 1
Chapter	Chapter: S4 Economics: Money and Banking
Level	S4

02　Questions (10 items)

FoundationMing pays for a lunch box with a 100 dollar note, keeps another note in his wallet for next month, compares two lunch boxes by their price tags, and promises to repay 100 dollars to a classmate next month. Which function of money does each use match?
FoundationThe required reserve ratio is 20 percent. A customer deposits 1,000 dollars of new money. Assuming no cash leakage, what is the maximum total deposit in the banking system, and how much of it is money created?
FoundationThe public holds 300 billion dollars of currency and 700 billion dollars of demand deposits. What is M1?
FoundationThe required reserve ratio is 25 percent. What is the deposit multiplier, that is the deposits supported by each dollar of reserves?
IntermediateTotal reserves in the banking system are 400 billion dollars and the required reserve ratio is 20 percent, with no extra cash held by the public. What is the maximum total deposit?
IntermediateM1 is 1,000 billion dollars, savings deposits are 600 billion and time deposits are 900 billion. What is M2?
IntermediateThe required reserve ratio rises from 20 to 25 percent with all else unchanged. How does the multiplier change, and by how much does the maximum total deposit fall for the same 1,000 dollar new deposit?
ChallengeThe required reserve ratio is 10 percent and the public keeps 20 dollars in cash for every 100 dollars deposited, a cash to deposit ratio of 0.2. Base money is 600 billion dollars. What are the actual money multiplier and the money supply?
ChallengeMoney supply is 800 billion dollars, velocity is 5 and real output is 2,000 billion. Using the equation of exchange MV equals PY, what is the price level?
Error redoA student says a bank that receives a 1,000 dollar deposit can lend out all 1,000 dollars. With a required reserve ratio of 20 percent, what is wrong, and what is the most the bank can lend?

03　Answers and one-line notes

#	Answer	One-line note
1	Medium of exchange, store of value, unit of account and standard of deferred payment, in that order	Paying completes a transaction, so it is the medium of exchange; keeping purchasing power for later is the store of value; comparing values by price tags is the unit of account; borrowing now and repaying later is the standard of deferred payment.
2	Total deposits reach 5,000 dollars, of which 4,000 dollars is newly created money	One thousand divided by 0.2 gives 5,000, and taking away the original 1,000 leaves 4,000 created by repeated lending and redepositing.
3	M1 is 1,000 billion dollars	M1 counts currency held by the public plus demand deposits, so 300 plus 700 gives 1,000 billion.
4	The multiplier is 4	The multiplier is the reciprocal of the reserve ratio, so one divided by 0.25 is 4.
5	2,000 billion dollars	Four hundred divided by 0.2 gives 2,000, since each dollar of reserves supports five dollars of deposits.
6	M2 is 2,500 billion dollars	M2 adds savings and time deposits to M1, so 1,000 plus 600 plus 900 gives 2,500 billion.
7	The multiplier falls from 5 to 4, and the maximum deposit drops from 5,000 to 4,000, a fall of 1,000 dollars	One over 0.2 is 5 and one over 0.25 is 4, so 1,000 times 5 against 1,000 times 4 differs by 1,000; a tighter reserve ratio squeezes the power to create deposits.
8	The multiplier is 1.2 over 0.3, that is 4, and the money supply is 2,400 billion dollars	With cash leakage the multiplier is one plus c over rr plus c, so 1.2 over 0.3 is 4, and 4 times 600 billion is 2,400 billion, far below the 10 times available without leakage.
9	P equals 2	MV gives 4,000 billion, and dividing by real output of 2,000 billion gives 2, so the price level is twice the base year.
10	It ignores the required reserve, so 200 dollars must be kept and at most 800 dollars can be lent	One thousand times 0.2 is 200 kept as reserves, leaving 800 to lend, and the system as a whole supports up to 5,000 dollars of deposits through repeated redepositing.

04　What to do after marking

After marking, redo only the wrong items and write down which step went wrong (formula, unit, or misread number).
Repeat the same item two days later; move to the next paper only when both attempts are correct.
Parents only need the answer and note columns; there is no need to explain every item.

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Questions and answers are written originally by the TutorZone team and are not taken from any school, publisher or examination authority paper. Every value is checked by computer.