Question

Define Marshall-Lerner condition and J-curve. Explain the relation between the two concepts.

Answer 1

Marshal Learner Condition for stability states that when the sum of the price elasticity of demand for exports and imports in absolute terms is greater than 1 then it is stable. If the sum of the price elasticity is less than one it is unstable and when equal to one it is inconclusive. It predominantly highlights the fact that devaluation will induce an improvement in the balance of payment only if the sum of demand elasticity is greater than one.

|PEdx+PEdm|>1.....stable

|PEdx+PEdm|<1...unstable

|PEdx+PEdm|=1...inconclusive.

A nations trade balance can worsen after devaluation or depreciation but improves later due to the tendency of the domestic currency price of imports to rise faster than export prices, therefore, J curve effect states that a trade deficit can worsen after devaluation but improve in the medium term but this depends on the marshall learner condition.

Relationship between Marshall Learner condition and J effect is -

|PEdx+PEdm|>1, During this condition, the depreciation or devaluation will improve the current account

Imagine country A has experienced current account deficit hence depreciation of the currency, in the medium to long term the current account balance induces a surplus(rising J curve) but this is possible only if the marshall learner condition is met. The balance is important but just after the depreciation, the current account deficit worsens as there is a time lag as it takes time for the value of imports to decrease and exports to increase.