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 ?
Results show that there is a clear J-curve effect and also Marshall-Lerner condition holds.
The ratio can be interpreted as nominal or real trade balance (Bahmani-Oskooee, 1991) and also the ratio in a logarithmic model gives the Marshall-Lerner condition exactly rather than as an approximation (Boyd et al.
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.
The Marshall-Lerner condition is an indirect method of assessing the effectiveness of devaluation in improving trade balance.
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.
They have reported that Marshall-Lerner condition for devaluation is satisfied for Pakistan and thus devaluation will be successful in improving the trade balance.
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).
The traditional theoretically expected result may not be guaranteed because the Marshall-Lerner condition or some of its underlying conditions (such as infinite supply elasticity) may not hold.
In this paper we use Johansen's cointegration methodology to re-investigate the long-run trade elasticities and existence of the Marshall-Lerner condition.
Hasan and Khan (1994), using 3SLS technique for annual data (1972-1991), conclude that the Marshall-Lerner condition for Pakistan is satisfied and a devaluation ought to be successful in improving the trade balance.
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.