External sector — effects of devaluation: Under which condition is a currency devaluation more likely to improve the trade balance and benefit the economy? Base your answer on demand elasticities for exports and imports (Marshall–Lerner condition). Choose the correct condition.
General Knowledge
Indian Economy
Difficulty: Medium
Choose an option
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AWhen the sum of price elasticities of demand for exports and imports exceeds one (high elasticities)
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BWhen both export and import demands are perfectly inelastic
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CWhen domestic inflation immediately rises faster than the exchange-rate pass-through
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DWhen the government simultaneously imposes strict import licensing quotas
Answer
Correct Answer: When the sum of price elasticities of demand for exports and imports exceeds one (high elasticities)
Explanation
Given data
- Devaluation makes exports cheaper and imports costlier in foreign currency terms.
Concept / ApproachMarshall–Lerner condition: Devaluation improves the trade balance if the absolute sum of export and import demand elasticities > 1. Then the quantity response dominates the price effect, raising export receipts and reducing import outgo.
ReasoningHigh elasticities → large volume response → trade balance improves. Inelastic demands or rapid domestic inflation can offset/negate benefits.
Final AnswerWhen (|εx| + |εm|) > 1, i.e., high elasticities.