Assume that the multiplier effect for Mexico is 0.85 for an increase in spending by the U.S. government by $1. Therefore, a $20 billion decrease in spending by the U.S. government results in:

Question

Quizplus · Accepted Answer

The formula for the multiplier effect is 1/(1-MPC), where MPC is the marginal propensity to consume. If the multiplier effect for Mexico is 0.85, then the MPC must be 0.15 (1-0.85).

Therefore, the decrease in spending by the U.S. government of $20 billion has a multiplier effect in Mexico of:

(1/(1-0.15)) * (-$20 billion) = -$17 billion

This means that Mexican real GDP will decrease by $17 billion. So, the correct answer is (D) a $17 billion decrease in Mexican real GDP.

Assume That the Multiplier Effect for Mexico Is 0