MARSHALL LERNER CONDITION The condition states that, for a currency devaluation

Question

MARSHALL LERNER CONDITION

The condition states that, for a currency devaluation tohave a positive effect on trade balances, the sum of priceelasticity of income ( in absolute value ) must be greater thanone.

The M-L Condition and the J curve show the relationship between theexchange rate of a nation’s currency and the country’sbalance of trade.

If a country’s currency depreciates relative to othercurrencies, then this should lead to an improvement in thecountry’s balance of trade. The weaker dollar now means thatforeigners will now have to spend less of their dollars in order togain one dollar’s worth of local currency. Since the localdollar is now worth less, locals will now have to pay more forimports; hence reducing the level of imports.

What matters is not whether a country imports less and exportsmore, rather, whether the increase in income form exports exceedsthe decrease in expenditure from imports for a particular country.M-L condition examines the price elasticises of demand for exportsand imports for a particular country.

E.g. country A experiences a devaluation of its currency

If foreigners demand for exports from country A is relativelyelastic, then a slightly weaker dollar will cause a dramaticincrease in the demand for A’s output, causing export incomefor A to increase dramatically. On the other hand, ifA’s demand for imports is highly price elastic, then aslightly weaker dollar will cause A’s demand for imports todecrease drastically, causing a reduction in A’s expenditurefrom imports.

Explanation / Answer

The condition states that, for a currency devaluation to have a positive effect on trade balances, the sum of priceelasticity of income ( in absolute value ) must be greater than one. I'm no expert in neither economics or English, but are yousure "sum of price elasticity of income ( in absolute value ) must be greater than one." is correct?Wikipedia says "the sum of price elasticity ofexports and imports(in absolute value) must be greater than 1." http://en.wikipedia.org/wiki/Marshall_Lerner The rest seems right, but it is two years since I learned it.

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