Answer to Question #303550 in Finance for Royd

Question

What is the Marshall-Lerner condition for a stable foreign exchange market? For an

unstable market? For a depreciation to leave a nation’s Balance of Payment unchanged?

Answer 1

The Marshall-Lerner condition for a stable foreign exchange market is that a country's devaluation of its currency will lead to an improvement in its balance of trade with the rest of the world only if the sum of the price elasticities of its exports and imports is greater than one.

For an unstable market where the sum of the price elasticities of demand for exports and imports is less than one, the Marshall-Lerner condition states that the increase in import expenditure will be greater than the increase in export revenue, which will worsen the balance of trade and deteriorate balance of payments.

According to the Marshall-Lerner condition, for a depreciation to leave a nation's balance of payment unchanged, the M-L condition that the sum of the magnitudes of the elasticities exceeds 1 must hold. This is because indirect positive quantity effect outweighs the direct negative effect of depreciation on balance of trade.