Marshall Lerner Condition

J-curve

Learning outcomes:

State the Marshall-Lerner condition and apply it to explain the effects of

depreciation/devaluations.
Explain the J-curve effect in relation to the Marshall Lerner Condition

Price Elasticity of Demand & Total Revenue Test

Price Elasticity of Demand: measures the
responsiveness of consumers to a change of
price.
Total Revenue Test

PED > 1 - upper region of Demand curve a decrease in Price leads to an increase in
Total Revenue
PED < 1 - lower region of the demand
curve - an increase in price leads to an
increase in Total Revenue
PED = 1 - Total Revenue is maximized

https://image.slidesharecdn.com/ipptchap006-150112202003-conversiongate01/95/elasticity-14-638.jpg?cb=1421096005

Persistent Current Account Deficit

Persistent Current Account deficit puts downward pressure on the currency.
Currency fluctuations between countries should correct the imbalances in the
current account. Example: Tanzania
Weaker Tsh. - foreigners must give up less of their currency in order to
get Tsh.
Imports become more expensive for Tanzania since it cost more Tsh. to
purchase foreign currencies - imports should decrease.
Weaker Tsh. makes their exports cheaper as foreigners must give up
less of their currency to purchase Tanzanian goods.
The decrease in imports and increase in Tanzanian exports should
reduce the current account deficit.

Marshall Lerner Condition

Marshall Lerner Condition (MLC) states:
If PED for imports + exports is greater than 1 devaluation/depreciation of a countrys currency will lead to an
improvement in the current account deficit.
If PED for imports + exports is less than 1 - devaluation/depreciation
of a countrys currency will lead to a worsening of the current account
deficit.
If PED for imports + exports is equal to 1 - devaluation/depreciation of
a countrys currency will have no effect on the current account.

Reason:
Depreciation of the Tsh. in Tanzania:
Exports to foreigners - cheaper
Tanzania imports - more expensive
If PED (exports + imports) > 1 - consumers are
more responsive to changes in price
Think back to Total Revenue test
Exports become cheaper (price decreases) &
elastic demand - Total Revenue increase.
Imports - more expensive (price increase) &
elastic demand - Total Revenue decreases.
Increase exports - decrease imports current account improves.

https://image.slidesharecdn.com/ipptchap006-15011220200
3-conversion-gate01/95/elasticity-14-638.jpg?cb=14210960
05

Reason:
Depreciation of the Tsh. in Tanzania:
Exports to foreigners - cheaper
Tanzania imports - more expensive
If PED (exports + imports) < 1 - consumers are
less responsive to changes in price
Think back to Total Revenue test
Exports become cheaper (price decreases) &
inelastic demand - Total Revenue decreases.
Imports - more expensive (price increase) &
inelastic demand - Total Revenue decreases.
Decrease export TR - Increase import
spending - current account deteriorates.

Marshall Lerner Curve - J-curve

Period immediately following a

devaluation/depreciation, PED (Imports +
Exports) are very low. PED < 1.
MLC is not satisfied - current account (trade
balance) deteriorates.
Reason: determinant of PED - time lags consumer/producer need to adjust to price
changes.
As time passes, PED increase - PED (exports +
imports) > 1.
MLC is met - improvement in current account
(trade balance improves) - moves towards
surplus.

http://welkerswikinomics.com/blog/wp-content/uploads/2008/12/j-curve.png

Summary.
A depreciation/devaluation of a currency initially
leads to a deterioration in the current account in the
short-run (PED exports + imports < 1) due to
determinant of PED - time lag.
As time progresses, consumers and producers
become more responsive to changes in price (PED exports + imports > 1) and the
depreciation/devaluation of a currency leads to an
improvement in the current account. Current
account moves toward surplus.