ECONOMICS Money Multiplication and the Federal Reserve

Directions:
Read through the Background information then answer the questions below.
Background:
Sarah Saver goes to Fancy National Bank and deposits $1,000 that she earned from her summer job. She now has a checking account with a balance of $1,000 from which she can write checks. Fancy National Bank has a 10 percent reserve requirement. The bank will put $100 in its vault and lend out the rest to people who need loans. (10% of $1000 = $100)
If you recall from the lesson, fractional reserve banking is a banking system in which only a fraction of bank deposits are actual cash-on-hand and available for withdrawal; this helps expand the economy by freeing up capital that can be loaned out to other parties.
Ernie Entrepreneur walks into Fancy National Bank wanting to borrow $900 to start his new catering business. If the bankers decide that his project is worthwhile and he meets its criteria for a loan, the bank will loan him the $900. If Ernie puts the $900 in his checking account, he can then write checks for that amount. There is now $1,900 of money available ($1,000 in Sarah’s checking account and $900 in Ernie’s account) to be spent. In other words, $900 of new money has been created.
Questions:
1. (2.5 points) If Ernie next deposits a profit of $500 from the grand opening of his business, the money supply is now this amount:
$1400
2. (2.5 points) Mark Merchant needs to borrow money for his business. The bank has $10,000 in deposits. Remembering the 10 percent reserve requirement, what is the maximum that the bank can loan Mark?
$1000
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3. (5 points) Now that Mark Merchant has secured a loan for his business, how might he use that loan? Give two examples of how he could use the loan for improving his business and explain how each example will have an effect in the economy.

4. (5 points) Explain the roles and responsibilities of the Federal Reserve System. Answer in at least one complete paragraph.

5. (5 points) Compare and contrast the consequences – intended and unintended – of different monetary policy actions of the Federal Reserve Board to achieve macroeconomic goals of stable prices, low unemployment, and economic growth. What effects can occur with different Federal Reserve actions (such as increasing money supply or raising interest rates)? Answer in at least one complete paragraph.