**Understanding the Simple Deposit Multiplier vs. the True Deposit Multiplier****Topic Overview:**The simple deposit multiplier is a concept used to estimate how much money banks can potentially create with each unit of currency deposited. However, it's important to understand why this measure often overstates the true deposit multiplier, or the actual amount of money created in the economy.**Key Concept:**The simple deposit multiplier assumes that all money deposited in banks will be loaned out and circulated back into the system without any leakages or cash holdings by the public. **Real-World Considerations:**1. **Role of Banks:** - Banks hold reserves to meet regulatory requirements and unexpected withdrawals. - Not all deposits are loaned out as some funds are retained as required reserves.2. **Customer Behavior:** - Customers do not redeposit all the money they receive; they tend to hold some cash. - The preference for holding cash reduces the amount available for further deposits and lending.**Conclusion:**These factors lead to a reduction in the effective money multiplier, making it smaller than the simple theoretical model predicts. Understanding these discrepancies is crucial for accurately assessing the impact of monetary policy and banking activities on money supply.

Deposit Multiplier: The deposit multiplier is the greatest amount that a bank may create for each…

Explain why the simple deposit multiplier overstates the true deposit multiplier (the money multiplier). (Hint: Explain in terms of the role banks and their customers play in the actual money creation process.)

Explain why the simple deposit multiplier overstates the true deposit multiplier (the money multiplier). (Hint: Explain in terms of the role banks and their customers play in the actual money creation process.)

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

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Question

**Understanding the Simple Deposit Multiplier vs. the True Deposit Multiplier**

**Topic Overview:**
The simple deposit multiplier is a concept used to estimate how much money banks can potentially create with each unit of currency deposited. However, it's important to understand why this measure often overstates the true deposit multiplier, or the actual amount of money created in the economy.

**Key Concept:**
The simple deposit multiplier assumes that all money deposited in banks will be loaned out and circulated back into the system without any leakages or cash holdings by the public.

**Real-World Considerations:**

1. **Role of Banks:**
- Banks hold reserves to meet regulatory requirements and unexpected withdrawals.
- Not all deposits are loaned out as some funds are retained as required reserves.

2. **Customer Behavior:**
- Customers do not redeposit all the money they receive; they tend to hold some cash.
- The preference for holding cash reduces the amount available for further deposits and lending.

**Conclusion:**
These factors lead to a reduction in the effective money multiplier, making it smaller than the simple theoretical model predicts. Understanding these discrepancies is crucial for accurately assessing the impact of monetary policy and banking activities on money supply.

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