The Marshall Lerner Condition
In one line. The Marshall Lerner condition states that a depreciation improves the trade balance only if the sum of the price elasticity of demand for exports and for imports is greater than one. The J curve shows the trade balance worsening first, while demand is inelastic, then improving. Elasticities, not the size of the depreciation, decide whether a weaker currency helps. This is H2 only.
Exam relevance: a core A Level Economics topic, on ETG analysis of the last ten years. Taught the way an economics tutor who wrote the answer keys teaches it.
01What the Marshall Lerner condition is
The Marshall Lerner condition sets out exactly when a depreciation of the currency improves the trade balance, and it is an H2 only result that turns on elasticities rather than on the size of the currency change.
The Marshall Lerner condition states that a depreciation improves the trade balance only if the sum of the price elasticity of demand for exports (PEDx) and the price elasticity of demand for imports (PEDm) is greater than one.
This is an H2 only topic. A depreciation makes exports cheaper to foreign buyers and imports dearer to domestic buyers, which should, intuitively, improve the trade balance. The Marshall Lerner condition makes that intuition precise: the improvement happens only if demand on both sides is responsive enough, captured in the requirement that PEDx plus PEDm exceeds one. If the elasticities sum to less than one, a weaker currency does not help and can make the trade balance worse.
02Why elasticities govern the outcome
A depreciation changes the prices of exports and imports, but what happens to the trade balance depends on how much the quantities demanded respond, which is what the elasticities measure.
After a depreciation, exports are cheaper in foreign currency, so foreigners buy more, and imports are dearer in domestic currency, so residents buy fewer. Whether export revenue rises and the import bill falls by enough to improve the trade balance depends on how responsive each demand is. If demand is elastic, quantities respond strongly and the trade balance improves; if demand is inelastic, quantities barely move, the dearer imports still have to be paid for, and the import bill can rise. The Marshall Lerner condition packages this into a single test: the elasticities must sum to more than one for the quantity responses to outweigh the price effects.
A depreciation improves the trade balance if PEDx + PEDm > 1. If PEDx + PEDm < 1, the trade balance does not improve and may worsen.
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03The J curve
Even when the Marshall Lerner condition is met in the long run, the trade balance first worsens before it improves, because elasticities are low immediately after a depreciation.
In the short run, demand for exports and imports is price inelastic. Existing contracts are fixed in advance, buyers take time to find alternatives, and consumption habits are slow to change, so quantities barely respond at first. With imports now dearer but bought in much the same volume, the import bill rises and the trade balance worsens. Over time, as buyers adjust and demand becomes more elastic, the quantity responses come through, the condition is met, and the trade balance improves. Plotted against time, the trade balance traces a path shaped like the letter J, falling first and then rising above its starting point. Note that this page carries no J curve diagram, because the diagram is reserved for class; the path is followed from the description.
04Applying the condition
The condition is the bridge between exchange rate policy and the trade balance, so it is what tells you whether a deliberate depreciation will work.
When a policy maker weakens the currency to improve the trade balance, the Marshall Lerner condition is the test of whether the policy can succeed. If the relevant elasticities are high enough that they sum to more than one, the depreciation improves the trade balance after the short run J curve dip. If they are too low, the depreciation fails to help and may worsen the position, so the policy is misdirected. This is why elasticities, not the size of the currency move, govern whether a weaker currency improves the trade balance.
State the condition as PEDx + PEDm > 1, then reason from elasticities to the trade balance. Pair it with the J curve to show that even a successful depreciation worsens the balance first, which is the timing point examiners reward.
05Common misconceptions
A depreciation does not automatically improve the trade balance. The result depends on elasticities: if PEDx + PEDm is less than one, a weaker currency can leave the trade balance unchanged or worse. State the condition explicitly rather than assuming "cheaper exports means a better trade balance".
A second error is to confuse the J curve with the condition itself. The Marshall Lerner condition is about whether the trade balance improves at all; the J curve is about the timing, the short run worsening before the long run improvement. Keep the "whether" and the "when" separate.
06Test yourself
- State the Marshall Lerner condition and explain why a depreciation fails to improve the trade balance when it is not met.
- Explain, using elasticities, why the trade balance worsens in the short run after a depreciation before it improves.
- Why do elasticities, rather than the size of the depreciation, decide whether a weaker currency helps the trade balance?
07Questions students ask
The Marshall Lerner condition states that a depreciation of the currency will improve the trade balance only if the sum of the price elasticity of demand for exports and the price elasticity of demand for imports is greater than one. If the combined elasticities are too low, a weaker currency does not improve the trade balance and may worsen it. It is an H2 only topic.
The J curve describes how the trade balance moves after a depreciation. In the short run, demand for exports and imports is price inelastic, because contracts and buying habits take time to adjust, so the trade balance first worsens. As demand becomes more elastic over time and the Marshall Lerner condition is met, the trade balance then improves, tracing a path shaped like the letter J.
Because whether it helps depends on elasticities, not just on the price change. A depreciation makes exports cheaper and imports dearer, but if demand for both is price inelastic, the quantities barely respond and the higher import bill can outweigh the gain on exports, so the trade balance can worsen. Only when the Marshall Lerner condition holds, the elasticities sum to more than one, does a depreciation improve the trade balance.