Question

Suppose that

The Elasticity of Imports in the USA in the short Run is 0.5

The Elasticity of Imports in Japan in the short Run is -0.3

The Elasticity of Imports in the USA in the long Run is 1.2

According to the Elasticities approach to the Current Account Balance, if the Exchange Rate goes from Yen=$1/100 to Yen=$1/50 ...

a)		The Current Account Balance in the US will deteriorate in the short run, and improve in the long run
b)		The Current Account Balance in the US will improve in the short run and in the long run
c)		The Current Account Balance in the US will deteriorate in the short run and in the long run
d)		The Current Account Balance in the US will deteriorate in the short run, and improve in the long run as long as the elasticity of imports in Japan is strictly more than -0.2

Answer 1

We are given that elasticity of Imports in the USA in the short Run is 0.5 and in the long Run it is 1.2  The yen is depreciating and so dollar is appreciating. This implies that price of dollar (relative) will increase and this will reduce the quantity demanded of imports in the short run (being inelastic at 0.5) and will increase in the long run (as demand is elastic at 1.2).

Hence current account will experience a deficit in the short run but an improvement in the long run. When demand is elastic, price rises reduces revenue and so import bill will fall in long run and rise in short run. This depends upon the elasticity of Imports in Japan because yen is depreciating so yen will also experience an deficit in the short run.

Correct choice is The Current Account Balance in the US will deteriorate in the short run, and improve in the long run as long as the elasticity of imports in Japan is strictly more than -0.2.