Marshall-Lerner & J-Curve (DP IB Economics)

Revision Note

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Steve Vorster

Written by: Steve Vorster

Reviewed by: Jenna Quinn

The Marshall-Lerner Condition

  • When a currency is devalued in a fixed exchange rate system or experiences depreciation in a floating exchange rate system, it makes the country's exports cheaper 

  • Depreciation of the currency causes exports to be cheaper for foreigners to buy and imports to the UK are more expensive

  • The extent to which this depreciation improves the current account balance depends on the Marshall-Lerner condition

    • This follows the revenue rule which states that in order to increase revenue, firms should lower prices for products that are price elastic in demand

    • If the combined elasticity of exports/imports is less than 1 (inelastic), a depreciation (fall in price) will actually worsen the current account balance

The J-Curve Effect

  • It is also important to recognise that there is a time lag between the depreciation of the currency and any subsequent improvement in the current account balance

  • This time lag is explained by the J-Curve effect

    • It takes time for firms and consumers to respond to changes in price

    • Once it becomes evident that price changes will last for a longer period of time, firms and consumers change their patterns

    • E.g. a firm in the USA has been importing electric scooters from the UK. If the Euro depreciates, the price of scooters in France becomes relatively cheaper. In the short-term, the USA firm will not switch immediately to purchasing scooters from France as the exchange rate may soon bounce back. They also have a good relationship with their UK suppliers. In the long term they are likely to switch

     

The J Curve explains what happens to a trade balance over time when the country's currency depreciates

The J Curve explains what happens to a trade balance over time when the country's currency depreciates

Diagram Analysis

  • In the short run, the sum of PEDs for exports and imports was less than one / inelastic (or the Marshall-Lerner condition was not fulfilled) so the deficit widens

  • However, in the long run the Marshall-Lerner condition is met so it leads to a surplus

  • With any currency depreciation/devaluation, the trade balance will initially worsen before it improves

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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.