Marshall-Lerner Condition
What is Marshall-Lerner Condition?
The Marshall-Lerner condition states that a currency depreciation improves the trade balance only if the combined price elasticities of export and import demand exceed 1.
A weaker currency makes exports cheaper and imports more expensive, but whether the trade balance improves depends on how responsive trade volumes are to those price changes. If the sum of the absolute price elasticities of demand for exports and imports is greater than one, volume changes outweigh the worsening price effect and the trade balance improves; if less than one, it deteriorates. Because elasticities are low immediately after depreciation but rise over time, the condition explains the J-curve's delayed improvement. It is central to debates over whether devaluation can fix a trade deficit.
Marshall-Lerner Condition: a worked example
Solano trades 800 million each way, so its balance starts at zero. Its currency depreciates enough to raise import prices 10 percent in domestic currency and cut export prices 10 percent abroad. Case one, elasticities of 0.4 and 0.3 summing to 0.7. Exports rise 4 percent to 832; import volume falls 3 percent but each unit costs 10 percent more, so the bill is 800 x 1.10 x 0.97 = 853.6. The balance is -21.6 million, worse. Case two, elasticities of 0.9 and 0.6 summing to 1.5. Exports reach 872; imports cost 800 x 1.10 x 0.94 = 827.2. The balance is +44.8 million.
The mistake students make with marshall-lerner condition
Readers see the threshold of one and assume each elasticity has to clear it, so both export and import demand must be elastic. The condition applies to the sum. Export demand at 0.6 and import demand at 0.5 are each inelastic on their own, yet together they reach 1.1 and a depreciation improves the balance. Reading it as a per-good test is tempting because 1 is the familiar dividing line between elastic and inelastic for a single good.
Marshall-Lerner Condition questions
What happens if the Marshall-Lerner condition is not satisfied?
If the Marshall-Lerner condition fails, a depreciation makes the trade balance worse rather than better. Volumes move too little to compensate for the fact that every imported unit now costs more in domestic currency, so the import bill rises faster than export revenue does. A country in that position cannot devalue its way out of a trade deficit, at least not until elasticities have risen.
Why does the Marshall-Lerner condition add two elasticities together?
The Marshall-Lerner condition sums the two elasticities because a depreciation acts on the trade balance through two separate channels at once. Cheaper exports abroad raise export volume, dearer imports at home cut import volume, and both improvements together must outweigh the single adverse effect of paying more per imported unit. Starting from balanced trade, that comparison reduces to the two elasticities adding to more than one.
Does the Marshall-Lerner condition assume trade starts balanced?
The simple form of the Marshall-Lerner condition assumes trade starts balanced, with export value equal to import value. When a country begins with a large deficit the adverse price effect applies to a bigger import base, so the elasticity sum has to clear a threshold above one before a depreciation helps at all. The deeper the starting deficit, the stiffer the test becomes.
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