Answer the question on the assumption that the legal reserve ratio is 20 percent. Suppose that the Fed sells $500 of government securities to commercial banks (paid for out of commercial bank reserves) and buys $500 of securities from individuals, who deposit the cash in checking accounts.

As a result of the given transactions, reserves in the banking system will:

1)	remain unchanged.

2)	rise by $100.

3)	fall by $100.

4)	rise by $1,000.

answer:

3) fall by $100.

EXPLANATION

fall by $100
When fed sells $500 to commercial banks, banks keep 20% of deposit with themselves which is $100. Rest $400 will be loaned out in the economy. When fed buys $500 of securities, $500 is pulled out from the economy. Hence the total effect = $400 – $500 = – $100. Thus, in total there will be a fall in $100