Marshall-Lerner condition


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Marshall-Lerner Condition

In international trade, a theory stating that if the sum of price elasticity of a country's exports and the price elasticity of its imports is greater than one, a devaluation of that country's currency will improve its balance of trade. Devaluation does not improve the balance of trade if the sum is any lower.

Marshall-Lerner condition

the PRICE ELASTICITY OF DEMAND for IMPORTS and EXPORTS condition that must be satisfied if an EXCHANGE-RATE alteration (DEVALUATION or REVALUATION) is to be successful in removing a balance of payments deficit or surplus.

Specifically, the elasticity values for a successful devaluation, for example, are: demand for imports is price-elastic

demand for exports is price-elastic

How successful the devaluation is thus depends critically on the reaction of import and export volumes to the change in prices implied by the devaluation. If trade volumes are relatively elastic to price changes, the devaluation will be successful; that is, an increase in import prices results in a more than proportionate fall in import volume, reducing the total amount of foreign currency required to finance the import bill, while the decrease in export prices results in a more than proportionate increase in export volume, bringing about an increase in total foreign currency earnings on exports.

By contrast, if trade volumes are relatively inelastic to price changes, the devaluation will not succeed, that is, an increase in import prices results in a less than proportionate fall in import volume, increasing the total amount of foreign currency required to finance the import bill, while the decrease in export prices results in a less than proportionate increase in export volume, bringing about a fall in total foreign currency earnings on exports.

There are, however, a number of other factors that influence the eventual outcome of a devaluation, in particular the extent to which domestic resources are sufficiently mobile to be switched into export-producing and import-substitution industries. See DEVALUATION, BALANCE-OF-PAYMENTS EQUILIBRIUM, PRICE-ELASTICITY OF SUPPLY.

References in periodicals archive ?
1998), "Long-run Price Elasticities and the Marshall-Lerner Condition Revisited," Economics Letters 61(1): 101-109.
2012), "Testing the Marshall-Lerner Condition in Kenya," Economics and Finance Working Paper Series 22: 1-24.
Under the hypothesis of The Marshall-Lerner condition if the aggregate import and export demand become less than or equal to one in the long run the trade balance must get better.
Results show that there is a clear J-curve effect and also Marshall-Lerner condition holds.
There are three distinct methods of investigating the link between trade balance and real exchange rate or terms of trade, which includes testing the Marshall-Lerner condition, the J-curve, and the S-curve.
Arize (1986) reported that the Marshall-Lerner condition for devaluation was satisfied for a majority of countries in his sample that included nine African countries for the period 1960-1982.
J-curve is a phenomena which has been derived partially from the studies of Alfred Marshall and Abba Lerner, which gives it its name Marshall-Lerner condition in the situation where the balance of trade of a country is zero then elasticity in supply are never ending then an exchange rate decrease in value can initiate a surplus surge in the balance of payments of that country.
In theory, exchange rate depreciations would reduce imports and increase exports thereby contracting a country's trade deficit provided the well-known Marshall-Lerner condition that the sum of the export and import demand elasticities are at least equal to unity holds (for details, see Kulkarni, 1994).
In this paper we use Johansen's cointegration methodology to re-investigate the long-run trade elasticities and existence of the Marshall-Lerner condition.
The well known Marshall-Lerner condition states that a currency devaluation will improve a nation's trade balance if the sum of the elasticities of domestic demand for imports and foreign demand for exports is greater than 1.
A comparison of Marshall-Lerner condition across the four trading partners reveals that real devaluation is unlikely to improve our trade balance with USA and Germany while it can arrest the trade balance deterioration with UK and Japan.
In the early work, it was noted that a devaluation would improye the trade balance only if the Marshall-Lerner condition held, and this restriction was also necessary and sufficient for stability in the foreign exchange market.