Johnny Fatcat withdraws $15,000 from his checking account at The DL Bank. He pay
ID: 2755800 • Letter: J
Question
Johnny Fatcat withdraws $15,000 from his checking account at The DL Bank. He pays $10,000 to Sammy Loanshark, who puts the money in his checking account at The Sopranos Bank. Johnny uses the other $5,000 as paper for his hand-rolled cigarettes, all of which he smokes ("nothing smokes better than a $100 bill," he loves to tell his friends).
Assume that all banks hold only the required 10% reserves and always loan out the rest, and that no cash is held by the public.
a. What is the ultimate net effect on the money supply in the economy? Show your work.
b. Assume instead that Sammy uses the $10,000 he receives to pay back a loan from Bad Boys Bank. $8,000 goes to repay the loan itself, and $2,000 represents his interest payment.Show the immediate changes on Bad Boys Bank’s balance sheet resulting from Sammy’s payment.
c. Ultimately, what will be the total amount of new loans in the economy after Sammy’s payment? Show your work.
Explanation / Answer
Solution : Money in DL bank account = $15,000 Johny withdrews $15000 and give it to Sammy Sammy Receives $10000 and deposits in Sopranos Bank = $10,000 Johny burns the rest of the amount = $5,000 (a) As the amount of $5000 is burned by Johny so the amount of money supply would decrease by the same amount of $5000. (b) Effect in Bad Boys Bank’s balance sheet : Under Assets side: (i) Cash will be Incresed by $10000. (ii) Loans advances given will be reduced by $8000 under assets side. (iii) Current assets will be reduced by $2000 as interest is received. Note : If intereset on loan is not seperately classified the "Loans & advances" will be reduced by $10000 solely. ( c) New fund available with Bad Boys Bank $10000 (-) Reserve 10% $1000 Net new loan $9000 And Loan By John from DL bank = $15,000 less: Loan principle repaymeny = ($8,000)
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