Assume the United States exports 1,000 computers at a price of $3,000 each and i

Question

Assume the United States exports 1,000 computers at a price of $3,000 each and imports 150 UK autos at a price of £10,000 each. Assume that the dollar/pound exchange rate is $2 per pound. 1. (6 points) State what the Marshall-Lerner condition is. 2. (9 points) Calculate, in dollar terms, the U.S. export receipts, import payments, and trade balance rior to a depreciation of the dollar's exchange value. (10 points) Suppose the dollar's exchange value depreciates by 10 percent. Assuming that the ice elasticity of demand for U.S. exports equals 2.0 and the price elasticity of demand for U.s. ports equals 3.0, does the dollar depreciation improve or worsen the U.S. trade balance? Why? ??

Explanation / Answer

1. The Marshall–Lerner condition is the condition that an exchange rate devaluation or depreciation will only cause a balance of trade improvement if the absolute sum of the long-term export and import demand elasticities is greater than unity. If the domestic currency devalues, imports become more expensive and exports become cheaper due to the change in relative prices.

2. The export and import payments are $3,000,000 with net trade balance of 0 (Nil). the calculations are provided below:

3. if the dollar depreciates by 10% with export elasticity at 2 the exports become cheaper at the demand side (pound side) hence exports are bound to increase by 20% (2*10%) with price in dollar remaining same. however the imports are bound to get expensive by 10% in dollar terms and demand in dollar are bound to decease by 30% (3*10%). the trade balance is provided below:

hence the trade balance is netexports of 1.29 million in dollars.

the trade balance has positive impact on the depreciation because the elasticity is greater than 1 for both imports and exports hence as per Marshall–Lerner condition, depreciation in currency is positive impact on US.

Quantity Price in dollar Total Exports Computer 1000 3000 3000000 Imports Autos 150 20000 3000000 Net exports 0

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