Home » General Knowledge » Indian Economy

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.

Difficulty: Medium

When the sum of price elasticities of demand for exports and imports exceeds one (high elasticities)
When both export and import demands are perfectly inelastic
When domestic inflation immediately rises faster than the exchange-rate pass-through
When the government simultaneously imposes strict import licensing quotas

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 / Approach
Marshall–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.

Reasoning
High elasticities → large volume response → trade balance improves. Inelastic demands or rapid domestic inflation can offset/negate benefits.

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.

More Questions from Indian Economy

Discussion & Comments