Definition
Marshall-Lerner Condition
The Marshall-Lerner condition states that a currency devaluation improves the trade balance only if the combined price elasticities of exports and imports exceed one.
A weaker rupee helps the trade balance only when exports and imports are elastic enough, formally, the sum of export-demand and import-demand elasticities must be greater than 1. If demand is too inelastic, depreciation can worsen the balance.
This condition underlies the J-curve: elasticities are low immediately after depreciation (so the balance worsens) but rise over time (so it improves). It links exchange-rate policy to the price-elasticity concepts at the heart of microeconomics.
Related terms
- Trade DeficitA trade deficit occurs when the value of a country's goods imports exceeds its goods exports, forming a major part of the current account.
- Terms of TradeTerms of trade is the ratio of a country's export prices to its import prices; rising terms of trade mean exports buy more imports, improving national income.
- J-Curve EffectThe J-curve effect describes how a currency's depreciation tends to worsen the trade balance at first, because import costs rise immediately while export and import volumes take months to adjust, before the balance improves.
- Price Elasticity of DemandPrice elasticity of demand measures how sharply the quantity people buy responds to a change in price; elastic goods react strongly, inelastic ones barely react.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.