Assume that there is a rise in the trade deficit of a country due largely to the rise in a government budget deficit. Assume also that some commentators in the popular press claim that the increased trade deficit resulted from a decline in the quality of the country’s products relative to foreign products.

a. Assume that the country’s products did decline in relative quality during this period. How might 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 country’s real exchange rate and trade balance.

c. Does a decline in the quality of the country’s products have any effect on standards of living for its residents? (Hint: when a country’s residents sell goods to non-country residents, what do they receive in return?)