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    Question

    The devaluation of a country’s currency will lead to an improvement in its balance of trade with the rest of the world only if

    A Absolute sum of the price elasticities of its exports and imports is greater than one. Correct Answer Incorrect Answer
    B Absolute sum of the price elasticities of its exports and imports is less than one. Correct Answer Incorrect Answer
    C Sum of the price elasticities of its exports and imports is equal than one. Correct Answer Incorrect Answer
    D Sum of the price elasticities of its exports and imports is zero. Correct Answer Incorrect Answer

    Solution

    The Marshall–Lerner condition (after Alfred Marshall and Abba P. Lerner) is satisfied if the absolute sum of a country's export and import demand elasticities (demand responsiveness to price) is greater than one. If it is satisfied, then if a country begins with a zero-trade deficit then when the country's currency depreciates (e.g., it takes fewer yen to buy a dollar), its balance of trade will improve (e.g., the U.S. will develop a trade surplus with Japan). The country's imports become more expensive and exports become cheaper due to the change in relative prices, and the Marshall-Lerner condition implies that the indirect effect on the quantity of trade will exceed the direct effect of the country having to pay a higher price for its imports and receive a lower price for its exports.

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