4.6c Marshall-Lerner Condition

Question 1

Why is the MLC used?

Answer 1

The MLC is relevant when a country depreciates its currency to improve its current account deficit
–> This depreciation will only be successful if MLC is met

Question 2

What is the equation to calculate the MLC?

Answer 2

Price elasticity of demand for exports + Price elasticity of demand for imports > 1

PEDx + PEDm > 1

Question 3

What does the MLC condition have to be greater than?

Answer 3

1

The condition states that the current account will improve, after a depreciation, if the sum of the price elasticities of demand for imports and exports is greater than 1. The further above 1 the sum of the elasticities is, the greater the improvement in the current account will be.

Question 4

Does this graph meet the MLC?

Answer 4

NO!

The fall in import spending is smaller than the increase in import spending
–> Price inelastic demand for imports

Question 5

Does this graph meet the MLC?

Answer 5

YES

As fall in import spending is greater than increase in import spending ( - > +)
–> Price elastic demand for imports is price elastic

Question 6

Does this graph meet the MLC?

Answer 6

YES

Increase in export revenues are greater than the fall in export earnings
–> Price elastic demand for exports

Question 7

Does this graph meet the MLC?

Answer 7

NO

Increase in export revenues is SMALLER than the fall in export earnings
–> Price inelastic demand for exports

Question 8

What does the “J-curve” show?

Answer 8

The J curve shows that the MLC does not hold in the short-run, but it does in the medium to long-run.

This is because in the short-run there will be a few extra exports sold when prices fall. People overseas do not react immediately and so export demand takes time to change. On the other hand, imports have to be paid immediately so the current account will deteriorate in the short run.