Step 1: Understanding the Concept:
Credit creation is the process by which banks expand their deposits through the lending of reserves. It relies on the fact that not all depositors withdraw money at once.
Step 2: Key Formula or Approach:
\[ \text{Total Deposits} = \text{Initial Deposit} \times \frac{1}{LRR} \]
Step 3: Numerical Example:
Assume Initial Deposit = \(1,000\) and \(LRR = 10%\) (0.10).
1. Round 1: Bank receives \(1,000\). It keeps \(10%\) (\(100\)) as reserve and lends \(900\).
2. Round 2: The \(900\) is spent by borrowers and eventually comes back to the banking system as a new deposit. The bank keeps \(10%\) (\(90\)) and lends \(810\).
3. Round 3: This process continues. Each time, banks keep \(10%\) and lend the rest.
Total Credit Created:
\[ \text{Total Deposits} = 1,000 \times \frac{1}{0.10} = 10,000 \]
The bank started with \(1,000\) and created total deposits worth \(10,000\).
Step 4: Final Answer:
The commercial banks have multiplied the initial cash base by 10 times, thereby increasing the total money supply in the economy.