Question

Suppose the quality of Hong Kong products relative to foreign products deteriorates.

a. Explain how the quality deterioration of Hong Kong products affects Hong Kong’s exports at any given exchange rate.

b. Explain how the quality deterioration of Hong Kong products affects Hong Kong’s real exchange rate and trade balance.

c. Is it possible that the quality deterioration of Hong Kong products increases Hong Kong’s trade deficit?

Answer 1

a) When quality of Hong Kong's products relative to foreign products deteriorates it will reduce the demand for Hong Kong's products in the international market. People will be reluctant to buy the low quality products from Hong Kong and as a result exports of Hong Kong will reduce at any given exchange rate.

b) With quality deterioration the products of Hong Kong will be less preferred in international market and exports of the country reduces. Due to quality deterioration people of Hong Kong may prefer foreign goods and can lead to rise in imports. With a fall in exports and rise in impors, the trade balance ofthe country will be affected as there arises situation of trade deficit with imports greater than exports. With fall in demand for Hong Kong's products, the price of the products can fall. This can lead to fall in real exchange rate as Hong Kong needs to pay more of domestic goods to get an equivalent amount of foreign goods.

c) Quality deterioration can lead to increased trade deficit in Hong Kong. Exports will fall due to quality deterioration and imports can rise when domestic consumers starts preferring foreign goods due to their better quality. This can worsen the trade deficit of the country.