Question

Explain the J curve.

Answer 1

The J-curve is graphical representation of trade balance over time of an economy whose domestic currency has undergone through sustained devaluation or depreciation.

This macroeconomic phenomenon is experienced by a open economy under which domestic currency devaluation or depreciation initially result into worsening trade deficit due to relatively expensive imports, however, as cheaper exports start to pick up and expensive imports lowering down after a lag, the trade deficit gradually narrow down that eventually result in increasing trade surplus.

This situation arises because exports does not respond quickly to devaluation or depreciation and that imports demand shows a constant volume increase due to domestic demand. With devaluation or depreciation, value of imports increase sharply whereas the value of exports lag behind in the short run, resulting in worsening trade deficit.

However, after some time, exports pick up as they become relatively cheaper such that value of exports exceed value of imports and trade balance becomes positive.