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.