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S4 Economics: Money and Banking Paper 3 (credit creation, money supply and real interest)
S4 Economics: Money and Banking Paper 3 (credit creation, money supply and real interest)
Paper 3 runs the full credit creation chain: turn the reserve ratio into a multiplier, then find total deposits and newly created deposits. It then compares the make-up of M1 and M2, allows for cash leakage, and ends with real interest and purchasing power from nominal rates and inflation. All values are machine-checked; write the formula first, then substitute.
Quick answer A 20 percent reserve ratio turns 5,000 dollars into 25,000 dollars of deposits and 20,000 dollars of new credit; a multiplier of 4 with 25,000 million of reserves gives 100,000 million of deposits; M1 is 150,000 million; M2 is 300,000 million; a nominal 8 percent against 3 percent inflation gives a real 5 percent, and 10,000 dollars becomes 10,485.44 in purchasing power; a leakage of 0.25 cuts the multiplier from 5 to 2.78; selling 100,000 million of bonds withdraws 400,000 million; 2,000 dollars at 12.5 percent needs 250 in reserves and leaves 1,750 to lend.
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: Money |
| Level | S4 |
02 Questions (10 items)
- FoundationThe reserve ratio is 20 percent. A customer deposits 5,000 dollars. What is total deposits in the system?
- FoundationWith a reserve ratio of 25 percent, what is the deposit multiplier? If total reserves are 25,000 million, what are total deposits?
- FoundationThe public holds 40,000 million in cash and 110,000 million in current deposits. What is M1?
- FoundationTaking the same figures, savings deposits are 70,000 million and time deposits 80,000 million. What is M2?
- IntermediateThe nominal rate is 8 percent and inflation 3 percent. What is the real rate, and what purchasing power does a 10,000 dollar deposit have after one year?
- IntermediateA shopper pays for a book with a 50 dollar note. Which function of money does this show?
- IntermediateThe reserve ratio is 20 percent and the public holds 0.25 dollars of cash for every dollar of deposits. What is the actual deposit multiplier, to two decimal places?
- ChallengeThe central bank sells 100,000 million of bonds in the open market and the deposit multiplier is 4. By how much can the money supply contract?
- ChallengeA customer deposits 2,000 dollars and the reserve ratio is 12.5 percent. How much must be kept as reserves and how much can be lent?
- Error redoSomeone claims that a higher reserve ratio lets banks create more deposits. What is wrong?
03 Answers and one-line notes
| # | Answer | One-line note |
|---|---|---|
| 1 | 25,000 dollars. | Total deposits equal the initial deposit divided by the reserve ratio, that is 5,000 divided by 0.2. |
| 2 | The multiplier is 4 and total deposits are 100,000 million. | The multiplier is 1 divided by the reserve ratio, and 25,000 million times 4 gives 100,000 million. |
| 3 | M1 is 150,000 million. | M1 contains only cash and current deposits, so simply add the two. |
| 4 | M2 is 300,000 million. | M2 equals M1 plus savings and time deposits, that is 1,500 plus 700 plus 800. |
| 5 | The real rate is 5 percent and purchasing power is about 10,485.44 dollars. | The real rate is 8 minus 3 percent; purchasing power is 10,000 times 1.08 divided by 1.03. |
| 6 | Medium of exchange. | The note acts as the go-between in the exchange, so it works as a medium of exchange. |
| 7 | About 2.78. | The actual multiplier is 1 plus the cash ratio, divided by the reserve ratio plus the cash ratio, that is 1.25 over 0.45. |
| 8 | By up to 400,000 million. | Selling bonds takes 100,000 million of reserves out of the banks, and multiplying by 4 gives the contraction. |
| 9 | Reserves of 250 dollars and 1,750 dollars can be lent. | 2,000 times 0.125 gives 250, leaving 1,750 dollars to lend. |
| 10 | The opposite holds: a 25 percent ratio gives a multiplier of 4 and a 20 percent ratio gives 5, so a higher ratio means a smaller multiplier. | The multiplier is 1 divided by the reserve ratio, so a bigger denominator means less credit creation. |
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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