AP Macroeconomics Flashcards: Banking and the Expansion of the Money Supply
Written by AP Content Team, Verified for 2026 AP Exams, Last updated: May 2026
Review key ideas with interactive flashcards. This set includes 21 cards to help you master important concepts.
How does the money multiplier affect the expansion of the money supply?
The size of the expansion of the money supply depends directly on the value of the money multiplier; a larger multiplier leads to a larger potential expansion.
Card 1 of 21
All Flashcards (21)
How does the money multiplier affect the expansion of the money supply?
The size of the expansion of the money supply depends directly on the value of the money multiplier; a larger multiplier leads to a larger potential expansion.
What are excess reserves?
Excess reserves are a bank's reserves held above the legally required amount, which can be used for lending.
How does a bank's desire to hold excess reserves affect money creation?
When banks choose to hold excess reserves instead of lending them all out, it reduces the amount of money created in each step of the process, resulting in a smaller overall expansion of the money supply.
What is the role of excess reserves in the expansion of the money supply?
Excess reserves form the basis for the expansion of the money supply, as they are the funds that the banking system can use to create new loans.
What are the primary assets for a commercial bank shown on its balance sheet?
The primary assets for a commercial bank are its reserves (both required and excess) and the loans it has made to customers.
How does the public holding more currency (cash) affect money creation?
When the public holds more currency, that money is not deposited into the banking system, which means banks have fewer reserves to lend and the money multiplier effect is diminished.
Using a required reserve ratio of 10%, what is the maximum potential increase in the money supply from a new $1,000 deposit?
The money multiplier is 10 (1/0.10). The maximum potential increase in the money supply is $10,000 ($1,000 x 10).
If the required reserve ratio is 20% (0.20), what is the maximum value of the money multiplier?
The maximum money multiplier is calculated as 1 / 0.20, which equals 5.
What are depository institutions?
Depository institutions, such as commercial banks, are financial institutions that organize their assets and liabilities on balance sheets.
A bank receives a new deposit of $10,000. If the reserve ratio is 10%, what is the amount of its required reserves and excess reserves?
The required reserves are $1,000 (10% of $10,000), and the excess reserves are $9,000.
Define fractional reserve banking.
Fractional reserve banking is a system in which depository institutions hold only a fraction of deposits in reserve and lend out the rest.
If the required reserve ratio changes from 10% to 25%, what happens to the value of the money multiplier?
The money multiplier decreases from 10 (1/0.10) to 4 (1/0.25), reducing the banking system's ability to expand the money supply.
What is the money multiplier?
The money multiplier is the ratio of the money supply to the monetary base, indicating the maximum amount the money supply can increase from an initial change in reserves.
How are a bank's total reserves divided?
A bank's total reserves are divided into two categories: required reserves, which must be held, and excess reserves, which can be loaned out.
A bank has total reserves of $50,000 and checkable deposits of $200,000. If the reserve ratio is 10%, how much are its excess reserves?
Required reserves are $20,000 (10% of $200,000). Therefore, excess reserves are $30,000 ($50,000 total - $20,000 required).
Why might the actual expansion of the money supply be overstated by the simple money multiplier formula?
The prediction may be overstated because the simple formula does not account for a bank's desire to hold excess reserves or the public's choice to hold more currency.
What is the primary liability for a commercial bank shown on its balance sheet?
The primary liability for a commercial bank is its customer deposits, as this is money the bank owes to its depositors.
How do you calculate the maximum value of the simple money multiplier?
The maximum value of the money multiplier can be calculated as the reciprocal of the required reserve ratio (1 / RR).
What two factors can cause the actual money multiplier to be smaller than the maximum value calculated by 1/RR?
The actual money multiplier can be smaller if banks choose to hold excess reserves or if the public decides to hold more of its money as currency rather than depositing it.
Explain the basic process of how the banking system creates money.
The banking system creates money by using excess reserves from an initial deposit to make a loan, which is then deposited in another bank, allowing that bank to lend out its new excess reserves.
What are required reserves?
Required reserves are the portion of deposits that banks are legally mandated to hold in their vaults or at the central bank, and cannot lend out.