Economics A2 · The macroeconomy. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.
Money is anything generally accepted in payment. It works as a medium of exchange, a unit of account, a store of value and a standard of deferred payment. The money supply is the total amount of money in an economy: narrow money is cash and deposits that can be spent at once; broad money also includes savings and time deposits.
Most money is created by commercial banks. They keep only a fraction of deposits as reserves and lend the rest, and each loan becomes a new deposit. This is credit creation.
The rate of interest is the price of money. Keynes explained it by the demand for and supply of money (liquidity preference); loanable funds theory explains it by saving and borrowing.
Students give the credit multiplier answer when the question asks for the extra lending. Total new deposits include the first deposit, so new loans = total deposits − the initial deposit.
Answer: $2,000 of new loans (total deposits rise by $2,500).
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