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The chapter notes that the rise in the U.S. trade deficit during the 1980s was due largely to the rise in the U.S. budget deficit. On the other hand, the popular press sometimes claims that the increased trade deficit resulted from a decline in the quality of U.S. products relative to foreign products.a. Assume that U.S. products did decline in relative quality during the 1980s. How did this affect net exports at any given exchange rate?b. Use a three-panel diagram to show the effect of this shift in net exports on the U.S. real exchange rate and trade balance.c. Is the claim in the popular press consistent with the model in this chapter? Does a decline in the quality of U.S. products have any effect on our standard of living? (Hint: When we sell our goods to foreigners, what do we receive in return?)
a) A decline in the quality of U.S. goods at a iven real exchange rate would reduce net exports, reducing the demand for dollars, thus shifting the demand curve for dollars to the left in the market for foreign exchange. b) The shift to the left of the demand curve for dollars leads to a decline in the real exchange rate. Because net capital outflow is unchanged,…

and net exports equals net capital outflow, there is no change in equilibrium in net exports or the trade balance. c) The claim in the popular press is incorrect. A change in the quality of U.S. goods cannot lead to a rise in the trade deficit.



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