Question

Starting from a position of trade-balance deficit, satisfaction of the Marshall-Lerner condition is sufficient to improve the trade balance measured in foreign exchange but not to improve the real trade balance.  Explain why.  In your answer explain the intuition behind the Marshall-Lerner condition.

Answer 1

Ans.) The trade balance deficit is a condition when the imports in an economy is more than the exports.Marshall -Lerners condition states that if the currency is devalued in an exchange market which means depreciating the currency for example 1 $ = 2 Yen for example than by devaluating Yen we means 1$ = 3 Yen. Such kind of devaluation or depriciation will help to improve the trade deficit only when the price elsticities of the demand for exports or imports is higer than unity or 1.Which means the combined price elasticities for the demand of exports and imports is highly elastic to the domestic currency . The fall in the currency with highly elastic demand for exports and imports will lead to rise in exports as now the exporters are earning more in terms of foreign exchange for example if 1 $ = 2 Yen and now the exchange rate is 1$ = 3 Yen than the exporter is gaining in terms of depriciating Yen as more Yen is earned per doller exports.Real trade balance is the difference in the monetary value of a countries imports and exports in terms of domestic currency here the quantum of exports and imports are taken into account and a net increase in physical output for exports is promoted and imports is limited through taxations and tariffs.Hence in  real GDP term Marshll -Lerners condition does not tell or render information to improve real trade balance which means a trade deficit when imports of goods and services taking into account domestic currency is more than exports of goods and services or vice verse the intuition

behind Marshall Lerners theory is basically to capture the movement in the foreign exchange market to analysis the benifit from the exports and impact from imports relative to foreign exchange rate keeping the price elasticities of demand for exports or imports that is the higher sensitivity of price to exchange rate of exports and imports.