When the value of one country’s currency changes, it can change how much it costs to buy goods from abroad and how much foreign buyers pay for your country’s goods. Two classic tools economists use to analyse this are the Marshall‑Lerner condition and the J‑curve.
The Marshall‑Lerner condition tells us when a depreciation (currency gets cheaper) will improve a country’s trade balance. It looks at the price elasticities of exports and imports.
Mathematically:
\$E = \varepsilonx + \varepsilony\$
where:
If \$E > 1\$, a depreciation will improve the trade balance. If \$E < 1\$, it will worsen it.
Exam Tip: Remember that a depreciation lowers the price of exports (good for sales) but raises the price of imports (bad for costs). The key is the sum of elasticities > 1.
Even if the Marshall‑Lerner condition is satisfied, the trade balance often gets worse at first after a depreciation, then improves later. This S‑shaped pattern looks like a “J”.
Why? Initially, the price of imports rises faster than the quantity of exports rises, so the trade balance dips. Over time, as export volumes increase and import volumes fall, the balance turns around.
Illustration:
| Time | Trade Balance |
|---|---|
| Immediately after depreciation | ↓ (worsens) |
| Short‑term (months) | Still ↓ but less steep |
| Long‑term (years) | ↑ (improves) |
Analogy: Think of a J‑curve like a roller coaster: you go down first (trade balance dips), then up (trade balance improves). The dip is temporary.
After the UK left the EU, the pound fell by about 10%. The Marshall‑Lerner condition was met because:
Initially, the trade balance worsened (J‑curve dip), but over 2–3 years it improved as export volumes rose and import volumes fell.
Exam Tip: When asked about a real‑world example, mention the UK/EU scenario and calculate \$E\$ to show the condition is satisfied. Then explain the J‑curve pattern.
Final Exam Tip: Always show your reasoning step‑by‑step: state the condition, plug in numbers, interpret the sign, then describe the J‑curve effect. Use clear, simple language and emojis if allowed to keep the answer engaging.