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Marshall-Lerner and J-Curve Revision Worksheet
This is a higher-level topic from section 4.7 of the syllabus.
These two theories allow students to pick up valuable evaluation marks. This topic has
appeared on all three papers (essay, short answer and data response).
If a country’s currency depreciates (under a floating regime) or is devalued (under a fixed
system) this should lead to an improvement in the economy’s current account position.
A depreciation/devaluation will lead to a fall in the price of exports and a rise in the price of
imports. Theory would suggest that demand for exports will rise and the demand for imports
would fall, hence the improvement in the current account.
Whether this improvement in the current account happens depends upon the price elasticity of
demand for exports and imports.
The Marshall-Lerner condition states that:
Following a fall in the value of a country’s currency there will be an improvement in the economy’s
current account position if the sum of elasticities of exports and imports is greater than one.
PED exports + PED imports > 1
You do not need to work out a numerical proof of this statement it is sufficient for you to
simply learn the Marshall-Lerner condition in the form found above and to use it as a point of
evaluation.
The J-Curve
As mentioned above there will be an improvement in an economy’s current account position
following a depreciation/devaluation if the sum of elasticities of imports and exports is greater
than 1. This will not necessarily happen immediately, there is a time lag involved as shown by
the J-Curve.
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Price elasticity of demand for exports and imports tends to be fairly inelastic in the short run
following a fall in the value of the exchange rate. It takes time for consumers and firms to
change there purchasing decisions. For instance firms may be tied into contracts with overseas
suppliers.
Question Bank
1. Explain why a depreciation of a country’s exchange rate may not always lead to an
improvement in its current account of the balance of payments [10]
2. Explain why a country coming out of a recession may have a balance of payments deficit [10]
3. A government decides to raise interest rates. How might this affect the external account? [10]
4. Explain why a depreciation of a country’s exchange rate might not improve its balance of
payments. [10]
5.
Extension Material
A numerical example of the Marshall-Lerner condition:
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