The rise in the US trade deficit during the 1980s was due largely to the rise in the US budget deficit. On the other hand, the popular press sometimes claims that the increased trade deficit resulted from a decline in the quality of US products relative to foreign products.
Assume that US products did decline in relative quality during the 1980s. How did this affect net exports at any given exchange rate?
Draw a three-panel diagram to show the effect of this shift in net exports on the US real exchange rate and trade balance.
Is the claim in the popular press consistent with the model that we learned in class? Does a decline in the quality of US products have any effect on our standard of living?