Question

Suppose the quality of Japan products relative to foreign products deteriorates. a. Explain how the quality deterioration of Japan products affects Japan’s exports at any given exchange rate. (3%) b. Explain how the quality deterioration of Japan products affects Japan’s real exchange rate and trade balance. (5%) c. Is it possible that the quality deterioration of Japan products increases Japan’s trade deficit? (2%)

Answer 1

A) As no country or consumer would wish to buy poor quality products, once the product quality of Japan falls, demand for Japanese products will fall in the world market. This will reduce Japanese exports

B) Due to fall in exports, trade balance (exports - imports) will also fall. Keeping imports unchanged

Due to fall in demand for Japanese exports, demand for Japanese currency will also fall. This will lead to currency depreciation for Japan

C) As export income falls and import expenditure remains unchanged, there will be an increase in trade deficit for Japan