Question:
Under which circumstances would the devaluation of currency be able to reduce the deficit in the current account?
(1) PEDx=0.6, PEDm=0.1
(2) PEDx=0.1, PEDm=0.4
(3) PEDx=0.5, PEDm=0.5
(4) PEDx=0.7, PEDm=0.2
(5) PEDx=0.8, PEDm=1.6
Correct Answer:
(5)
Answer Explanation:
The Marshall-Lerner condition dictates that a currency devaluation will only improve a trade deficit if the sum of the Price Elasticity of Demand for exports and imports is strictly greater than 1 ($PED_x + PED_m > 1$). Let’s check Option 5: $0.8 + 1.6 = 2.4$. Since 2.4 is greater than 1, this condition will successfully reduce the deficit.
Topic: Exchange Rates Year: 2019
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