Marshall-Lerner Condition: Explanation, Formula, and Economic Impact

by Yum Yum Mama Team February 5, 2025

What is the Marshall-Lerner Condition?

The Marshall-Lerner Condition states that a depreciation (or devaluation) of a currency will improve a country’s trade balance if the sum of the price elasticities of demand for exports and imports is greater than one.

In simple terms, this means that if the demand for exports and imports is sufficiently responsive to price changes, a weaker currency will reduce the trade deficit by increasing export revenue and decreasing import expenditure.

What is the Marshall-Lerner Condition Simplified?

If:

Where:

E_x = Price elasticity of demand for exports
E_m = Price elasticity of demand for imports
| | denotes absolute values

Then, a currency depreciation will lead to an improvement in the trade balance.

However, if the sum is less than one, a currency depreciation will worsen the trade balance.

What Does the Marshall-Lerner Condition Illustrate?

The Marshall-Lerner Condition explains the relationship between exchange rates and trade balance. It shows:

How a currency depreciation affects exports and imports.
Why some countries benefit from a weaker currency, while others do not.
The importance of elasticity of demand in international trade.

What are the Assumptions of the Marshall-Lerner Condition?

No Immediate Response – It takes time for consumers and businesses to adjust their purchasing habits.
Elastic Demand for Trade Goods – Demand for exports and imports must be price-sensitive.
No Government Intervention – No artificial controls (e.g., tariffs, subsidies) impact trade flows.
Stable Economic Conditions – Inflation, interest rates, and global market conditions remain unchanged.

Marshall-Lerner Condition Formula

The condition holds when:

This means that the combined responsiveness of demand for exports and imports must be high enough for trade balance improvement.

Marshall-Lerner Condition in A-Level Economics

For A-Level Economics, the Marshall-Lerner Condition is a key topic under exchange rates and balance of payments. Students must understand:

How elasticity impacts trade balance.
The J-Curve effect and short-term trade deficits.
Real-world examples of currency depreciation.

Marshall-Lerner Condition and the J-Curve

The J-Curve explains why the trade balance initially worsens after a depreciation before improving over time. This happens because:

Immediate import contracts remain unchanged, so spending on imports stays high.
Export demand takes time to increase as global consumers adjust.
Eventually, demand for exports rises, and the trade balance improves, forming a "J"-shaped curve.

Marshall-Lerner Condition Appreciation vs Depreciation

Depreciation – Can improve trade balance if the condition is met.
Appreciation – Strengthens the currency, making exports expensive and imports cheaper, potentially worsening the trade balance.

Marshall-Lerner Condition Summary

A currency depreciation improves trade balance only if the demand for exports and imports is elastic.
If demand is inelastic, depreciation worsens the trade deficit.
The J-Curve effect explains short-term trade deficits before long-term improvements.

Marshall-Lerner Condition PDF Resources

For further study, download PDFs covering:

Marshall-Lerner Condition Derivation – In-depth mathematical explanations.
Marshall-Lerner Condition Economics Discussion – Analysis of real-world applications.
Freeman, 1984 Stakeholder Theory PDF – Related studies on trade and business impact.

Conclusion

The Marshall-Lerner Condition is a fundamental economic principle explaining how exchange rate fluctuations influence trade balance. Understanding its formula, assumptions, and real-world implications is crucial for economists, policymakers, and students.

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