Question

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

Answer 1

Marshall-Lenner condition is satisfied when the sum of absolute values of a country's export and import demand elasticities is greater than one. When this conditions hold true, and a country begins with a zero trade deficit then while its currency depreciates, its balance of trade will improve or in short it will be in trade surplus with other countries. Therefore country's imports become expensive and on the flipside exports become cheaper due to this change, in short the Marshall-Lerner condition implies that the indirect effect on the trade quantity will exceed the direct effect of the country having to pay a higher price for its imports and in turn receive a low price for its exports.

The J Curve theory states that a country's trade deficit will be worse off intially after the depreciation of its currency due to the fact that higher prices on imports will be exceeding the reduced volume of imports.

The trading volumes of imports and exports experience microeconomic changes only in the intial stages. And as the time progresses, export levels surge due to the attractive prices in the perspective of foreign buyers.

The relationship between J curve and Marshall lener condition is pretty straightforward. When the sum of the absolute elasticity of import and export demand is greater than 1, then an intial devaluation improves the current account in the long run. This is the Marshall lenner condition and is exactly the same as interpreted by the J curve. The image below shows how a J curve looks.

The long run increase in surplus after initial currency devaluation as stated in the Marshall Lenner condition is shown above. This is known as the J curve effect.

Hope this helps. Cheers!