CUET UG Economics Booster Test 3 - Credit Creation and Money Multiplier -

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CUET UG Economics Booster Test 3 - Credit Creation and Money Multiplier

⏱️ 30 Minutes

❓ 20 Questions

📌 Answers are locked once submitted — results and explanations appear at the end.

CUET UG Economics Booster Test 3 - Credit Creation and Money Multiplier

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QUESTION 1 OF 20

Analyze the assumptions behind the lending process:
I. The lending process relies on the assumption that all depositors will demand their money at the exact same time.
II. Banks must balance lending to maximize profit while ensuring enough liquid funds are available to repay depositors on demand.

Answer Review

1 Analyze the assumptions behind the lending process:
I. The lending process relies on the assumption that all depositors will demand their money at the exact same time.
II. Banks must balance lending to maximize profit while ensuring enough liquid funds are available to repay depositors on demand.

A Only I is correct

B Both are correct

C Only II is correct

D Neither is correct

💡 Short Explanation

�� Banks assume that all depositors will not withdraw simultaneously. �� Banks lend only after maintaining required reserves. �� Profit maximization is balanced with liquidity management.

✅ Correct Answer Explanation

Statement I is incorrect because commercial banking is based on the assumption that all depositors do not withdraw their deposits at the same time. If every depositor demanded cash simultaneously, banks could not continue normal lending operations. Statement II is correct because banks aim to maximize profits by lending as much as possible while still maintaining adequate reserves and liquidity to honour withdrawal requests and comply with RBI regulations. Therefore, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → Only I is correct
Incorrect because Statement I is false.
�� Option B → Both are correct
Incorrect because Statement I contradicts the basic principle of fractional reserve banking.
�� Option D → Neither is correct
Incorrect because Statement II accurately explains commercial bank behaviour.

🎯 Strategy

Used

Elimination

Application:

Evaluate each statement independently using the NCERT explanation of fractional reserve banking.

Final Logic:

Only Statement II correctly describes the lending process.

🧠 Memory Trick

"Not Everyone Withdraws Together."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Credit Creation by Commercial Banks

2 Arrange the macro-level deposit expansion chain logically:
1. RBI sets the CRR percentage legally.
2. A primary deposit is introduced into the commercial banking system.
3. The bank retains the required fractional reserve.
4. Excess reserves are lent out, turning into derivative deposits.

A 1, 2, 3, 4

B 2, 1, 4, 3

C 4, 3, 2, 1

D 3, 1, 2, 4

💡 Short Explanation

�� RBI first determines the reserve ratio. �� Deposits enter the banking system. �� Banks retain reserves before lending.

✅ Correct Answer Explanation

The correct sequence is: 1. The RBI legally fixes the Cash Reserve Ratio (CRR). 2. Customers deposit money in commercial banks. 3. Banks retain the required reserve as mandated by the RBI. 4. The remaining excess reserves are lent, creating new (derivative) deposits. Thus, Option A correctly represents the credit creation process.

❓ Why Other Options Are Incorrect

�� Option B → 2, 1, 4, 3
Incorrect because the CRR is predetermined before banks receive deposits.
�� Option C → 4, 3, 2, 1
Incorrect because lending cannot occur before deposits and reserve maintenance.
�� Option D → 3, 1, 2, 4
Incorrect because reserves cannot be maintained before deposits exist.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Arrange events according to the actual sequence of banking operations.

Final Logic:

Regulation precedes deposits, deposits precede reserves, and reserves precede lending.

🧠 Memory Trick

"Rule → Deposit → Reserve → Loan."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Deposit Expansion Process

3 In a bank's analytical balance sheet, ________ are recorded as assets because they represent legally binding claims the bank has on borrowers to return the funds.

A Demand deposits

B Net worth calculations

C Customer savings accounts

D Loans extended to the public

💡 Short Explanation

�� Loans create legal claims against borrowers. �� They generate future income through interest. �� Therefore, they are assets of the bank.

✅ Correct Answer Explanation

Loans granted by commercial banks represent legally enforceable claims on borrowers. Borrowers are obligated to repay both the principal and the interest. Since loans are expected to generate future economic benefits, they are recorded as assets in the bank's balance sheet. Hence, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Demand deposits
Incorrect because demand deposits are liabilities, not assets.
�� Option B → Net worth calculations
Incorrect because net worth is an accounting result rather than an asset.
�� Option C → Customer savings accounts
Incorrect because customer deposits are liabilities owed by the bank.

🎯 Strategy

Used

Odd One Out

Application:

Differentiate between assets and liabilities on the commercial bank balance sheet.

Final Logic:

Only loans represent claims owned by the bank.

🧠 Memory Trick

"Loan = Bank's Claim."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Assets of Commercial Banks

4 Why is a cash deposit made by a customer considered a strict liability for the commercial bank?

A Because the bank uses it to print new currency

B Because it is kept safely in a vault indefinitely

C Because the bank owes this money back to the depositor on demand

D Because it generates high interest for the bank

💡 Short Explanation

�� Deposits belong to customers. �� Banks are legally obligated to repay them. �� Hence, deposits are liabilities.

✅ Correct Answer Explanation

Customer deposits are liabilities because the bank has a legal obligation to return the deposited money whenever the depositor demands it (subject to the terms of the account). Although the bank may use part of the deposits for lending, ownership of the deposited funds remains with the customer. Therefore, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → Because the bank uses it to print new currency
Incorrect because commercial banks cannot print currency.
�� Option B → Because it is kept safely in a vault indefinitely
Incorrect because banks lend a significant portion of deposits after maintaining required reserves.
�� Option D → Because it generates high interest for the bank
Incorrect because interest earned by the bank does not determine why deposits are classified as liabilities.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Identify why deposits appear on the liabilities side of a bank's balance sheet.

Final Logic:

A liability represents money the bank owes to others.

🧠 Memory Trick

"Customer's Money = Bank's Liability."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Liabilities of Commercial Banks

5 Assertion (A): A bank's assets include the loans it gives to the public.
Reason (R): Loans are considered assets because the bank never expects them to be repaid.

A Both false

B A true, R false

C Both true, R explains A

D A false, R true

💡 Short Explanation

�� Loans are assets because they are claims on borrowers. �� Banks expect full repayment with interest. �� The Reason contradicts the concept of lending.

✅ Correct Answer Explanation

The Assertion is true because loans are recorded as assets since they represent claims that commercial banks have on borrowers. The Reason is false because banks expect borrowers to repay the loan along with interest. The expectation of repayment is precisely why loans are treated as assets. Therefore, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → Both false
Incorrect because the Assertion is correct.
�� Option C → Both true, R explains A
Incorrect because the Reason is false.
�� Option D → A false, R true
Incorrect because the Assertion is true and the Reason is false.

🎯 Strategy

Used

Elimination

Application:

Verify the truth of both the Assertion and the Reason independently.

Final Logic:

Loans are assets because banks expect repayment, not because they do not.

🧠 Memory Trick

"Asset = Expect Repayment."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Assets of Commercial Banks

6 Match the balance sheet elements and logic:

List I	List II
1. Reserves	a. Deposits kept with RBI + vault cash
2. Loans	b. Financial claim on borrower
3. Accounting equation	c. Assets = Liabilities + Net Worth
4. Spread	d. Difference between lending and deposit rates

A 1-b, 2-c, 3-a, 4-d

B 1-a, 2-b, 3-c, 4-d

C 1-c, 2-d, 3-b, 4-a

D 1-d, 2-a, 3-b, 4-c

💡 Short Explanation

�� Reserves consist of cash and deposits with the RBI. �� Loans represent claims on borrowers. �� Spread is the difference between lending and deposit rates.

✅ Correct Answer Explanation

The correct matching is: Reserves → Deposits kept with RBI + vault cash (a) Loans → Financial claim on borrower (b) Accounting equation → Assets = Liabilities + Net Worth (c) Spread → Difference between lending and deposit rates (d) These definitions are consistent with the NCERT discussion on commercial bank balance sheets and credit creation. Therefore, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → 1-b, 2-c, 3-a, 4-d
Incorrect because reserves are not financial claims on borrowers, and loans are not the accounting equation.
�� Option C → 1-c, 2-d, 3-b, 4-a
Incorrect because the accounting equation and spread are incorrectly matched.
�� Option D → 1-d, 2-a, 3-b, 4-c
Incorrect because reserves are not the interest spread, and loans are not deposits with the RBI.

🎯 Strategy

Used

Option Grouping

Application:

Associate each banking term with its standard NCERT definition before comparing the complete combinations.

Final Logic:

Only Option B correctly matches all four concepts.

🧠 Memory Trick

"Reserve–Cash, Loan–Claim, Spread–Difference."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Balance Sheet and Banking Terminology

7 Which of the following statements about deposits is correct?
I. Time deposits are highly liquid and payable immediately on demand.
II. Demand deposits are not considered legal tenders because cheques drawn on them can be refused.

A Only I is correct

B Both I and II are correct

C Neither I nor II is correct

D Only II is correct

💡 Short Explanation

�� Time deposits are not payable on demand. �� Demand deposits are money but not legal tender. �� Cheques may legally be refused as payment.

✅ Correct Answer Explanation

Statement I is false because time deposits have a fixed maturity period and generally cannot be withdrawn on demand without conditions or penalties. Statement II is true because cheques drawn on demand deposits are not legal tender. They function as a widely accepted means of payment, but a seller is legally permitted to refuse payment by cheque. Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Only I is correct
Incorrect because Statement I is false.
�� Option B → Both I and II are correct
Incorrect because Statement I is incorrect.
�� Option C → Neither I nor II is correct
Incorrect because Statement II correctly describes demand deposits.

🎯 Strategy

Used

Elimination

Application:

Evaluate the truth of each statement independently using NCERT definitions of demand and time deposits.

Final Logic:

Only Statement II is correct.

🧠 Memory Trick

"Time Waits, Demand Pays."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Demand Deposits and Time Deposits

8 If a bank creates a balance sheet where initial deposits are Rs 1000, and it loans out Rs 800 while keeping Rs 200 as reserves, what is the net worth of this bank?

A Rs 800

B Rs 200

C Rs 0

D Rs 1000

💡 Short Explanation

�� Assets = Loans + Reserves. �� Assets = ₹800 + ₹200 = ₹1000. �� Net Worth = Assets − Liabilities = ₹0.

✅ Correct Answer Explanation

The bank's balance sheet is: Assets Loans = ₹800 Reserves = ₹200 Total Assets = ₹1000 Liabilities Deposits = ₹1000 Therefore, Net Worth = Assets − Liabilities = ₹1000 − ₹1000 = ₹0 Thus, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → Rs 800
Incorrect because ₹800 is the value of loans, not net worth.
�� Option B → Rs 200
Incorrect because ₹200 represents reserves.
�� Option D → Rs 1000
Incorrect because it equals total assets, not net worth.

🎯 Strategy

Used

Substitution

Application:

Calculate total assets first, then subtract liabilities.

Final Logic:

��1000 − ₹1000 = ₹0.

🧠 Memory Trick

"Net Worth = Assets − Liabilities."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Balance Sheet and Net Worth

9 If the RBI fears that banks are 'over-lending' in an inflationary environment, it can theoretically ________ the Cash Reserve Ratio to absorb excess liquidity.

A Eliminate

B Increase

C Decrease

D Ignore

💡 Short Explanation

�� Increasing the CRR reduces excess reserves. �� Reduced reserves lower lending capacity. �� Money supply and inflationary pressures decline.

✅ Correct Answer Explanation

When inflation is high due to excessive lending, the Reserve Bank of India (RBI) may increase the Cash Reserve Ratio (CRR). A higher CRR requires banks to hold more reserves with the RBI, leaving less money available for lending. This reduces credit creation, slows money supply growth, and helps control inflation. Therefore, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → Eliminate
Incorrect because the CRR is an essential monetary policy instrument and cannot simply be eliminated.
�� Option C → Decrease
Incorrect because reducing the CRR would increase lending and potentially worsen inflation.
�� Option D → Ignore
Incorrect because the RBI actively uses the CRR to regulate liquidity.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Connect inflationary conditions with contractionary monetary policy.

Final Logic:

Inflation ↑ → CRR ↑ → Lending ↓.

🧠 Memory Trick

"Inflation High? Raise CRR."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Cash Reserve Ratio and Monetary Policy

10 Assertion (A): CRR is an optional guideline that commercial banks can choose to ignore if they need to lend more.
Reason (R): CRR only applies to the Reserve Bank of India, not to commercial banks like SBI.

A A false, R true

B A true, R false

C Both true, R explains A

D Both false

💡 Short Explanation

�� CRR is a mandatory statutory requirement. �� Commercial banks must comply with the CRR prescribed by the RBI. �� The CRR does not apply only to the RBI.

✅ Correct Answer Explanation

The Assertion is false because the Cash Reserve Ratio (CRR) is a legally binding requirement prescribed by the RBI. Commercial banks cannot ignore it even if they wish to increase lending. The Reason is also false because the CRR applies to commercial banks, which are required to maintain the prescribed cash reserves with the RBI. Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → A false, R true
Incorrect because the Reason is also false.
�� Option B → A true, R false
Incorrect because the Assertion is false.
�� Option C → Both true, R explains A
Incorrect because both statements are false.

🎯 Strategy

Used

Elimination

Application:

Verify the truth of both the Assertion and the Reason using the statutory definition of the CRR.

Final Logic:

Both statements contradict the NCERT explanation of reserve requirements.

🧠 Memory Trick

"CRR = Compulsory RBI Rule."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Cash Reserve Ratio (CRR)

11 While CRR focuses strictly on cash balances, SLR mandates that banks keep a portion of reserves in what specific condition?

A Illiquid long-term corporate shares

B Physical real estate holdings

C Foreign currency only

D Liquid form in the short term

💡 Short Explanation

�� SLR requires banks to maintain liquid assets. �� Liquid assets can be converted into cash quickly. �� This ensures banks can meet short-term obligations.

✅ Correct Answer Explanation

The Statutory Liquidity Ratio (SLR) requires commercial banks to maintain a prescribed proportion of their deposits in the form of liquid assets, such as cash, gold, or approved government securities. Unlike the Cash Reserve Ratio (CRR), which specifically requires banks to maintain cash reserves with the RBI, the SLR focuses on maintaining assets that can readily be converted into cash. Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Illiquid long-term corporate shares
Incorrect because such shares are risky and not sufficiently liquid for SLR purposes.
�� Option B → Physical real estate holdings
Incorrect because buildings and land are fixed assets and cannot be easily converted into cash.
�� Option C → Foreign currency only
Incorrect because SLR is not limited to foreign currency holdings.

🎯 Strategy

Used

Odd One Out

Application:

Identify the option that satisfies the requirement of maintaining liquidity.

Final Logic:

Only liquid assets meet the objective of the Statutory Liquidity Ratio.

🧠 Memory Trick

"SLR = Stay Liquid Ready."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Statutory Liquidity Ratio (SLR)

12 Match the regulatory/banking metrics:

List I	List II
1. CRR	a. Cash reserve percentage with RBI
2. SLR	b. Short-term liquid reserves
3. Money Multiplier	c. 1 / CRR
4. Bank Rate	d. Rate at which RBI lends to banks

A 1-b, 2-a, 3-d, 4-c

B 1-a, 2-c, 3-b, 4-d

C 1-a, 2-b, 3-c, 4-d

D 1-d, 2-b, 3-a, 4-c

💡 Short Explanation

�� CRR is the cash reserve maintained with the RBI. �� SLR refers to liquid assets maintained by banks. �� Money Multiplier equals 1 divided by the CRR.

✅ Correct Answer Explanation

The correct matching is: CRR → Cash reserve percentage with RBI (a) SLR → Short-term liquid reserves (b) Money Multiplier → 1 / CRR (c) Bank Rate → Rate at which RBI lends to banks (d) Each pair corresponds to the standard NCERT definition of these monetary policy concepts. Therefore, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → 1-b, 2-a, 3-d, 4-c
Incorrect because CRR and SLR are interchanged, and Bank Rate is not the money multiplier.
�� Option B → 1-a, 2-c, 3-b, 4-d
Incorrect because SLR is not equal to 1/CRR.
�� Option D → 1-d, 2-b, 3-a, 4-c
Incorrect because CRR is not the Bank Rate, and the Money Multiplier is not the cash reserve percentage.

🎯 Strategy

Used

Option Grouping

Application:

Recall the standard definitions of each monetary policy instrument and compare the complete set of matches.

Final Logic:

Only Option C correctly matches all four banking metrics.

🧠 Memory Trick

"CRR–Cash, SLR–Liquid, Multiplier–1/CRR, Bank Rate–RBI Loan."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Monetary Policy Instruments

13 Order the calculation steps for finding total deposits generated from an initial reserve:
1. Identify the CRR percentage.
2. Calculate the money multiplier formula as 1/CRR.
3. Identify the initial cash reserve amount.
4. Multiply the initial reserve by the money multiplier.

A 4, 3, 2, 1

B 1, 2, 3, 4

C 2, 1, 4, 3

D 3, 1, 4, 2

💡 Short Explanation

�� Begin with the CRR. �� Calculate the money multiplier. �� Apply the multiplier to the initial reserve.

✅ Correct Answer Explanation

The logical sequence for calculating total deposits is: 1. Determine the Cash Reserve Ratio (CRR). 2. Calculate the Money Multiplier = 1 ÷ CRR. 3. Identify the initial reserve amount available. 4. Multiply the initial reserve by the money multiplier to obtain the maximum total deposits. Thus, the correct order is 1 → 2 → 3 → 4. Therefore, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → 4, 3, 2, 1
Incorrect because multiplication cannot occur before identifying the multiplier.
�� Option C → 2, 1, 4, 3
Incorrect because the multiplier cannot be calculated before identifying the CRR.
�� Option D → 3, 1, 4, 2
Incorrect because the multiplier must be computed before applying it.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Arrange the computational steps according to the logical order used in solving money multiplier problems.

Final Logic:

Identify CRR → Compute Multiplier → Apply to Initial Reserve.

🧠 Memory Trick

"CRR → Multiplier → Reserve → Deposits."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Money Multiplier Calculation

14 The deposit expansion process conceptually creates money out of thin air, acting similarly to the historical example of Lala the ________ provided in the text.

A Goldsmith

B Blacksmith

C Tailor

D Moneylender

💡 Short Explanation

�� NCERT uses the historical example of a goldsmith. �� Goldsmiths accepted deposits and issued receipts. �� These receipts later functioned similarly to money.

✅ Correct Answer Explanation

The NCERT chapter explains the origin of banking using the example of goldsmiths. Goldsmiths accepted valuables for safekeeping and issued receipts, which gradually began circulating as a medium of exchange. This historical example illustrates how banks create deposits through lending, making Option A correct.

❓ Why Other Options Are Incorrect

�� Option B → Blacksmith
Incorrect because blacksmiths manufactured metal goods and had no connection with the origin of banking.
�� Option C → Tailor
Incorrect because tailoring has no historical link to deposit banking.
�� Option D → Moneylender
Incorrect because although moneylenders gave loans, the NCERT example specifically refers to a goldsmith, not a moneylender.

🎯 Strategy

Used

Odd One Out

Application:

Recall the historical example used in the NCERT explanation of the evolution of banking.

Final Logic:

Only the goldsmith example is discussed in relation to deposit creation.

🧠 Memory Trick

"Goldsmith → First Banker."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Origin of Banking and Credit Creation

15 If the total required reserves in an economy have reached exactly Rs 100 under a CRR of 20%, what must be the total expanded value of bank deposits?

A Rs 100

B Rs 200

C Rs 400

D Rs 500

💡 Short Explanation

�� CRR = 20%. �� Money Multiplier = 1 ÷ 0.20 = 5. �� Total Deposits = ₹100 × 5 = ₹500.

✅ Correct Answer Explanation

The money multiplier is calculated using the NCERT formula: Money Multiplier = 1 ÷ CRR Given: CRR = 20% = 0.20 Money Multiplier = 1 ÷ 0.20 = 5 Since total required reserves equal ₹100, the maximum total deposits are: ₹100 × 5 = ₹500 Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Rs 100
Incorrect because this is only the reserve amount, not the total deposits.
�� Option B → Rs 200
Incorrect because it underestimates the multiplier effect.
�� Option C → Rs 400
Incorrect because it does not satisfy the multiplier formula.

🎯 Strategy

Used

Substitution

Application:

Substitute the reserve ratio into the money multiplier formula and multiply by the reserve amount.

Final Logic:

��100 × (1 ÷ 0.20) = ₹500.

🧠 Memory Trick

"20% Reserve = Five Times Deposits."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Money Multiplier and Deposit Expansion

16 Select the correct analytical outcomes:
I. By increasing the reserve ratio from 20% to 25%, the money multiplier falls from 5 to 4.
II. An increase in the reserve ratio forces banks to call back some loans to meet the new requirements.

A Only I is correct

B Only II is correct

C Both I and II are correct

D Neither I is correct

💡 Short Explanation

�� Money Multiplier = 1 ÷ CRR. �� Increasing CRR reduces banks' lending capacity. �� Banks may need to reduce credit creation or recall loans (where feasible) to satisfy higher reserve requirements.

✅ Correct Answer Explanation

Statement I is correct. Money Multiplier = 1/CRR At CRR = 20%, Money Multiplier = 1/0.20 = 5 At CRR = 25%, Money Multiplier = 1/0.25 = 4 Thus, increasing the CRR reduces the multiplier. Statement II is also correct. When the RBI raises the reserve ratio, banks must maintain higher reserves. To comply, they reduce lending and, where necessary, recover outstanding loans as they mature or restrict fresh lending. This effectively reduces credit creation. Therefore, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → Only I is correct
Incorrect because Statement II is also conceptually correct regarding tighter reserve requirements reducing lending.
�� Option B → Only II is correct
Incorrect because Statement I is mathematically correct.
�� Option D → Neither I is correct
Incorrect because both statements are correct.

🎯 Strategy

Used

Substitution

Application:

Calculate the money multiplier using the formula and then apply the concept of reserve requirements.

Final Logic:

Higher CRR → Multiplier falls → Lending capacity falls.

🧠 Memory Trick

"CRR ↑ = Multiplier ↓ = Loans ↓."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Reserve Ratio, Money Multiplier and Credit Control

17 Assertion (A): The amount of new loans given out decreases in each successive round of the deposit expansion process.
Reason (R): This happens because the RBI dynamically reduces the CRR percentage in every single round.

A Both false

B A true, R false

C Both true, R explains A

D A false, R true

💡 Short Explanation

�� Each lending round is smaller than the previous one. �� The CRR remains constant throughout the process. �� Smaller deposits naturally produce smaller loans.

✅ Correct Answer Explanation

The Assertion is true because every new deposit is smaller than the previous deposit after the required reserve has been deducted. Consequently, each successive loan becomes smaller. The Reason is false because the RBI does not change the CRR during every round of credit creation. The CRR remains fixed unless officially revised by the RBI. Therefore, Option B is correct.

❓ Why Other Options Are Incorrect

�� Option A → Both false
Incorrect because the Assertion is true.
�� Option C → Both true, R explains A
Incorrect because the Reason is false.
�� Option D → A false, R true
Incorrect because the Assertion is true and the Reason is false.

🎯 Strategy

Used

Elimination

Application:

Evaluate the Assertion and Reason independently before checking whether one explains the other.

Final Logic:

Loan sizes decrease because deposits shrink each round, not because the CRR changes.

🧠 Memory Trick

"Same CRR, Smaller Loans."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Deposit Expansion Process

18 What mathematically stops the theoretical infinite loop of deposit expansion?

A The point where the total accumulated required reserves equal the initial cash deposit

B When the bank completely runs out of willing borrowers

C When the Net Worth of the bank drastically exceeds its liabilities

D The immediate legal intervention of the government after three rounds

💡 Short Explanation

�� Every lending round requires reserves. �� Total reserves gradually accumulate. �� Eventually, all initial reserves are absorbed.

✅ Correct Answer Explanation

In the theoretical money multiplier model, every round of lending requires a fraction of deposits to be kept as reserves. The lending process continues until the sum of all required reserves equals the original primary deposit (reserve money). At that point, no excess reserves remain for further lending. Therefore, Option A is correct.

❓ Why Other Options Are Incorrect

�� Option B → When the bank completely runs out of willing borrowers
Incorrect because this is a practical limitation, not the mathematical limit in the theoretical model.
�� Option C → When the Net Worth of the bank drastically exceeds its liabilities
Incorrect because net worth does not determine the end of the multiplier process.
�� Option D → The immediate legal intervention of the government after three rounds
Incorrect because no such rule exists.

🎯 Strategy

Used

Contextual/Tonal Matching

Application:

Identify the theoretical stopping condition described in the NCERT credit creation model.

Final Logic:

The multiplier process ends when excess reserves become zero.

🧠 Memory Trick

"No Excess Reserve = No New Loan."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Credit Creation and Deposit Expansion

📄 Passage

"Table 3.3 demonstrates its balance sheet. M1 = Currency + Deposits = 0 + 500 = 500. Thus, money supply increases from Rs 100 to Rs 500. Given a CRR of 20 per cent, the bank cannot give a loan beyond Rs 400. Hence, requirement of reserves acts as a limit to money creation."

According to the analytical constraints in the passage, what is the absolute limit of total loans the bank can give out if initial deposits were Rs 100 and total expanded deposits successfully reached Rs 500?

A Rs 100

B Rs 500

C Rs 80

D Rs 400

💡 Short Explanation

�� Total deposits become ₹500. �� Required reserves = 20% of ₹500 = ₹100. �� Maximum loans = ₹500 − ₹100 = ₹400.

✅ Correct Answer Explanation

The passage clearly states: Total deposits = ₹500 CRR = 20% Required reserves: = 20% × ₹500 = ₹100 Maximum loans: = ₹500 − ₹100 = ₹400 Hence, the maximum amount that can be lent is ₹400. Therefore, Option D is correct.

❓ Why Other Options Are Incorrect

�� Option A → Rs 100
Incorrect because ₹100 represents the required reserves, not loans.
�� Option B → Rs 500
Incorrect because banks cannot lend the reserve portion.
�� Option C → Rs 80
Incorrect because ₹80 is only the first-round loan in the multiplier process.

🎯 Strategy

Used

Substitution

Application:

Apply the reserve ratio to the total deposits and subtract reserves.

Final Logic:

��500 − ₹100 = ₹400.

🧠 Memory Trick

"Deposits − Reserves = Loans."

📚 Class XII – Introductory Macroeconomics – Chapter: Money and Banking – Topic: Credit Creation and Balance Sheet

📄 Passage

If 'Currency' held by the public in the economy is assumed to be 0, what does the passage state the total M1 money supply becomes after the full credit creation cycle?

A Rs 100

B Rs 400

C Rs 500

D Rs 0

💡 Short Explanation

�� M1 = Currency + Deposits. �� Currency = ₹0. �� Deposits = ₹500.

✅ Correct Answer Explanation

According to the passage, M1 = Currency + Deposits Given: Currency = ₹0 Deposits = ₹500 Therefore, M1 = ₹0 + ₹500 = ₹500 The passage explicitly states that the money supply rises from ₹100 to ₹500 after the complete credit creation process. Hence, Option C is correct.

❓ Why Other Options Are Incorrect

�� Option A → Rs 100
Incorrect because ₹100 is only the initial money supply before credit expansion.
�� Option B → Rs 400
Incorrect because ₹400 represents total loans, not M1.
�� Option D → Rs 0
Incorrect because deposits remain part of M1 even when currency is zero.

🎯 Strategy

Used

Substitution

Application:

Use the M1 formula directly with the values provided in the passage.

Final Logic:

M1 = ₹0 + ₹500 = ₹500.

🧠 Memory Trick

"Zero Currency + ₹500 Deposits = M1 ₹500."

📚 Bottom of Form

CUET UG Economics Booster Test 3 - Credit Creation and Money Multiplier

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