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 Bankâs balance sheet resulting from Sammyâs payment.
c. Ultimately, what will be the total amount of new loans in the economy after Sammyâs payment? Show your work.
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