The Impact of Changes in Exchange Rates

Question 1

Marshall-Lerner Condition

Answer 1

States that a currency depreciation will only correct a current account deficit if:

PEDx + PEDm is greater than 1 (Elastic)

PEDx Price decreases, TR increases, export revenue decreases.

PEDm Inelastic –> price increases, TR increases - Import revenue increases.

Therefore PED(x-m) inelastic = price decreases, TR decreases. This will worsen the deficit on the current account.

Question 2

The J Curve

Answer 2

In reality, when a currency weakens, it is inelastic in the short-run because it takes time to adjust to the new price. Therefore it is inelastic in the short-run, but elastic in the long-run.

https://www.economicshelp.org/wp-content/uploads/2009/02/j-curve-effect-600x427.png