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S6 Economics: Money Supply and Credit Creation (Paper 1: basics)
S6 Economics: Money Supply and Credit Creation (Paper 1: basics)
This first paper builds the base: the three functions of money, the make up of M1, the reciprocal link between reserve ratio and multiplier, and direct substitution into the equation of exchange.
Direct answers Always write the formula before substituting, and keep the multiplier step and the deposit total step separate to avoid rounding in between.
01 Paper details (check answers afterwards)
| Item | Detail |
|---|---|
| Questions | 10 |
| Suggested time | 20 |
| Difficulty mix | Foundation 3 · Intermediate 3 · Challenge 3 · Error redo 1 |
| Chapter | Chapter: S6 Economics: Money Supply and Credit Creation |
| Level | S6 Economics |
02 Questions (10 items)
- FoundationWhat are the three main functions of money in a modern economy?
- FoundationWhat does Hong Kong M1 include?
- FoundationAt a 20 per cent required reserve ratio, what is the maximum total deposits from $1,000 of new deposits?
- IntermediateAt a 10 per cent ratio with $2,000 of initial deposits, how much new deposit money can the system create, excluding the original $2,000?
- IntermediateWhat is the deposit multiplier when the required reserve ratio is 25 per cent?
- IntermediateIn the equation of exchange MV = PY, with M = 500 and V = 4, what is PY?
- ChallengeWith M = 300, V = 5 and Y = 1,500, what is the price level P?
- ChallengeWhat is the deposit multiplier at a required reserve ratio of 12.5 per cent?
- ChallengeWhat is the main source of profit for a commercial bank?
- Error redoA student says that with a 20 per cent reserve ratio the multiplier is 0.2, so $1,000 creates only $200. What is wrong?
03 Answers and one-line notes
| # | Answer | One-line note |
|---|---|---|
| 1 | Medium of exchange, unit of account and store of value | The three cover everyday exchange, the quoting of prices and carrying purchasing power across time, and money without them is incomplete. |
| 2 | Legal tender notes and coins plus demand deposits with licensed banks | Demand deposits can be spent at once by cheque or transfer, so they belong with cash in the narrowest measure. |
| 3 | $5,000, which is 1,000 divided by 0.20 | Twenty cents of each dollar is held as reserve and the rest is lent and redeposited, so the ceiling is the initial deposit divided by the ratio. |
| 4 | $18,000, the $20,000 total less the original $2,000 | Work out the total as 2,000 divided by 0.10 and subtract the initial deposit to leave the newly created part. |
| 5 | 4, because 1 divided by 0.25 | The multiplier is the reciprocal of the reserve ratio, so a lower ratio gives a larger multiplier. |
| 6 | 2,000 | Money stock times velocity equals the price level times real output, which is nominal output. |
| 7 | 1 | Rearranging MV = PY gives P equal to MV divided by Y, which is 1,500 over 1,500. |
| 8 | 8 | One divided by 0.125 is 8, so a fractional ratio is handled in exactly the same way. |
| 9 | The spread between loan interest and deposit interest, plus service fees | Banks take deposits at a lower rate and lend at a higher rate, and that spread is the core income. |
| 10 | The multiplier is the reciprocal, 5, giving $5,000 of total deposits and $4,000 of new deposits | The multiplier must exceed one because the ratio is only the fraction kept as reserve, not the multiplier itself. |
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.
Three basics: money serves as a medium of exchange, a unit of account and a store of value; Hong Kong M1 is notes and coins plus demand deposits; and the deposit multiplier is the reciprocal of the reserve ratio, so a 20 per cent ratio gives 5.Tutor Registration →
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