Question

Define Marshall-Lerner condition and J-curve. Explain the relation between the two concepts (25 pts.)

Answer 1

As we know that, The J-curve effect is a phenomenon in which a period of negative or unfavorable returns is followed by a gradual recovery that stabilizes at a higher level than before the decline.A country's trade balance experiences the J-curve effect if its currency becomes devalued. At first, the country's total value of imports (goods purchased from abroad) exceeds its total value of exports (goods sold abroad), resulting in a trade deficit. But eventually, the currency devaluation reduces the price of its exports. Consequently, the country's level of exports gradually recovers, and the country moves back to a trade surplus.

The Marshall-Lerner condition plays an important role in the elasticity approach of the balance of Payements.It is named after the economists who discovered it independently: Alfred Marshall and Abba Lerner.The condition seeks to answer the following question: when does a real devaluation (in fixed exchange rates) or a real depreciation (in floating exchange rates) of the currency improve the current-account balance of a country? The Marshall-Lerner condition states that a real devaluation (or a real depreciation) of the currency will improve the trade balance if the sum of the elasticities (in absolute values) of the demand for imports and exports with respect to the real exchange rate is greater than one,

The marshall-Lerner condition expresses that the real devaluation or real depreciation of the currency will improve trade balance when the sum of price elasticity of demand for imports and Exports is greater than one.

Elasticity of exports + elasticity of imports > 1.

Ex + Em >1.

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