Question
The Marshall-Lerner Condition (MLC) is required for a
currency devaluation/depreciation to improve a country's trade balance (Net Exports). The condition states that the sum of the absolute values of the price elasticities of demand for exports (ηX) and imports (ηM) must satisfy which relationship?Solution
Solution: · Currency Depreciation Effect: A currency depreciation makes exports cheaper for foreigners (increasing demand) and imports more expensive for domestic residents (decreasing demand). · Marshall-Lerner Condition (MLC): For the combined effect to lead to a net improvement in the trade balance, the quantity changes must be large enough to offset the negative value effect (the initial loss in value of a unit of domestic currency). This requires that the sum of the absolute values of the price elasticities of demand for exports and imports must be greater than one.
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