IB Economics HLTopic 4 — The Global EconomyHL onlyCore skill~11 min read
The Marshall-Lerner Condition and the J-Curve
Everyone says a weaker currency fixes a trade deficit. These two ideas are the small print. Marshall-Lerner tells you whether it works at all. The J-curve tells you when — and the honest answer is not for a while.
📚 What you need to know
A depreciation makes exports cheaper for foreigners and imports dearer at home.
Whether that improves the current account depends on the Marshall-Lerner condition.
The condition: PED for exports + PED for imports must be greater than 1.
If the combined elasticity is less than 1, a depreciation makes the balance worse.
Even when the condition is met, there is a time lag before the improvement shows up.
That lag produces the J-curve: the balance dips first, then recovers and rises above where it started.
The condition
The Marshall-Lerner condition
PEDexports + PEDimports > 1 then a depreciation improves the current account
The logic underneath it is the revenue rule you already know from elasticity. Cutting the price of something only raises total revenue if demand is price elastic. A depreciation cuts the foreign price of exports, so it only raises export revenue if foreign buyers respond strongly enough.
At the same time it raises the home price of imports. That only cuts import spending if domestic buyers respond strongly enough. Add the two responses together and compare with 1.
That last line matters. Students often assume both elasticities must be elastic. They do not — only the sum has to clear 1.
Countries that export raw commodities often fail this test. Their exports face inelastic world demand, and they import essentials like fuel and machinery that they cannot cut back on. For them a depreciation can genuinely make the current account worse.
Seeing it with numbers
Take a country where exports and imports both start at 100 units of currency, so the balance is zero. Its currency then depreciates by 10%.
🧩 How the arithmetic works
Exports. The foreign price falls 10%, so volume rises by PEDx × 10%. The home-currency price per unit is unchanged, so export revenue rises by exactly that percentage.
Imports. The home price rises 10%, so volume falls by PEDm × 10%. Import spending = 1.10 × (1 − that volume fall).
Compare. New exports minus new imports gives the new balance.
WORKED EXAMPLE 1
PED for exports is 0.6 and PED for imports is 0.3. The currency depreciates 10%. Exports and imports both start at 100. Calculate the new trade balance. [4]
Step 1: check the condition0.6 + 0.3 = 0.9, which is less than 1, so expect the balance to worsen.
Step 2: exports
Volume rises 0.6 × 10% = 6%, so export revenue = 100 × 1.06 = 106.0Step 3: imports
Volume falls 0.3 × 10% = 3%, but each unit costs 10% more.
Import spending = 100 × 1.10 × 0.97 = 106.7Step 4: the balance106.0 − 106.7 = −0.7The balance moves from 0 into a deficit of 0.7the depreciation made things worse, exactly as the condition predicted
WORKED EXAMPLE 2
Repeat the calculation with PED for exports of 0.9 and PED for imports of 0.5. [3]
Step 1: check the condition0.9 + 0.5 = 1.4, greater than 1, so expect an improvement.
Step 2: exports100 × 1.09 = 109.0Step 3: imports100 × 1.10 × 0.95 = 104.5Step 4: the balance109.0 − 104.5 = +4.5A surplus of 4.5 — the depreciation workedsame 10% depreciation, opposite outcome, and the only thing that changed was elasticity
The J-curve: the right answer, but late
Suppose the condition is met. The improvement still does not arrive straight away, because prices change instantly and quantities do not.
The dip is not a failure of the theory. It is the theory: in the short run, elasticities are too low to meet the condition, and they only rise as buyers get round to switching.
Why the dip happens
Contracts. Orders were signed months ago at agreed volumes. Nothing changes until they expire.
Habits and relationships. A firm with a reliable supplier does not switch over one price move, especially if it expects the rate to bounce back.
Search costs. Finding, testing and approving a new supplier takes time and money.
Supply capacity. Even where foreign demand does jump, domestic exporters may need to hire and invest before they can meet it.
Meanwhile the price effect is immediate. Import bills rise on day one, which is why the balance dips before it recovers.
Link this to policy. A government devaluing to fix a deficit should expect the figures to look worse for the first year or two. If it panics and reverses course, it never gets the benefit at all.
Reading a J-curve in an exam
Stage
What is happening
Why
Immediately after
Deficit widens
Import prices are up but volumes have not adjusted, so the import bill rises
The low point
Deficit stops getting worse
Volumes finally start responding as contracts expire and buyers switch
The recovery
Deficit narrows back to where it started
Export volumes are rising and import volumes are falling steadily
The long run
Balance moves into surplus
Elasticities have risen above 1, so the Marshall-Lerner condition is now met
💡 Exam tip
Quote the condition properly: PED for exports plus PED for imports must exceed 1. Half-remembered versions lose the mark.
When you draw a J-curve, label the axes trade balance and time, and mark the zero line clearly.
Explain the dip with a concrete reason: existing contracts, or the time it takes to switch supplier.
Link the two ideas in one sentence: the J-curve happens because elasticities are low in the short run and higher in the long run.
In evaluation, ask whether the country’s exports are commodities. If so, the condition may never be met.
⚠ Common mix-up
Both elasticities do not need to exceed 1. Only their sum does.
Falling import volumes do not mean falling import spending. Each unit costs more, so the bill can still rise.
The J-curve is not an argument against depreciation. It is an argument about timing.
Do not draw the J starting at zero every time. A country in deficit starts below the line, which is what the diagram above shows.
Marshall-Lerner is about the current account, not the exchange rate. The exchange rate has already moved; the question is what happens next.
Up next: Living With a Current Account Surplus — because a surplus brings its own set of problems, and most students assume it is simply good news.
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