The Impact of Declining U.S. Exports to Mexico on Aggregate Spending
How will U.S. aggregate spending be affected if exports to Mexico decline by $20 billion?
Options:
a) $40 billion
b) $60 billion
c) $80 billion
Answer:
The correct answer is c) $80 billion.
When U.S. exports to Mexico decline by $20 billion and the Marginal Propensity to Consume (MPC) is 0.75, the impact on U.S. aggregate spending can be calculated using the spending multiplier formula.
The Spending Multiplier is calculated as:
Spending Multiplier = 1 / (1 - MPC)
Given that MPC is 0.75:
Spending Multiplier = 1 / (1 - 0.75) = 4
Now, we multiply the decline in exports by the spending multiplier:
Drop in Aggregate Spending = $20 billion * 4 = $80 billion
Therefore, if U.S. exports to Mexico decline by $20 billion, U.S. aggregate spending will drop by $80 billion.