J curve Flashcards
Evaluation of a depreciation – the J curve answer
Initially the economy has a current account deficit, where the value of imports exceeds the value of exports, plus net primary and secondary income. Due to a depreciation of the currency at point A, exports become cheaper and imports become more expensive.
In the short term, the demand for imports and exports is relatively inelastic and thus the Marshall Lerner Condition is not met.
This may be due to companies having inflexible contracts with suppliers or customers. As a result, export revenue falls and import expenditure rises, worsening the current account deficit, as shown from point A to B.
Over time, export and import demand become more elastic as contracts run out and firms switch to cheaper suppliers; as a result, export revenue increases and import expenditure falls, improving the current account deficit after point B. The Marshall Lerner Condition is met where PEDx + PEDm ≥ 1 at point B.
