Marshall-Lerner condition

Marshall-Lerner Condition

The Marshall-Lerner Condition (named after the British economist Alfred Marshall and the American economist Abba Ptachya Lerner) is a mathematical condition which holds for international trade to be beneficial to all parties. This condition applies to countries which specialize in their production combined with free trade, and suggests that a country will gain more from free trade when its production links together the production of other countries.

In economic terms, the condition states that if the sum of the trade elasticities of exports and imports are greater than minus one (-1) then the country in question will gain from international trade. Trade elasticity is a measure of how changes in other variables (market size, prices, income level, costs, etc) affect the demand and/or supply of a country’s exports and imports.

If the sum of the elasticities of the exports and imports of a country is greater than minus one, then a change in the prices of the country’s exports and imports (one goes up while the other goes down) will lead to an increase in the overall welfare of the country. This is because when exports go up, the demand for domestic production increases, leading to increased production, which in turn leads to greater domestic economic growth. When imports go down, foreign producers must also reduce their production, leading to increased demand for domestic production.

The condition also has implications for international trade issues such as tariffs, in that tariffs can lead to an increase in the price of imports, leading to a worsening of the balance of trade and decreased overall economic welfare. It is also suggested that, owing to the Marshall-Lerner Condition, countries which have exports and imports which are highly elastic in response to exchange rate changes, may not benefit from the devaluation of their currency.

The Marshall-Lerner Condition is a useful tool for economic policy makers in analyzing the economic impact of free trade and protectionist policies, such as tariffs and exchange rate manipulation. It suggests that in order to maximize benefit from international trade, countries should focus on developing production which is linked to that of other countries, as well as ensure that their exports and imports are reasonably elastic. Additionally, tariffs and currency devaluation may have an adverse effect on their overall economic welfare.

Marshall-Lerner Condition is an economic principle that states that a countrys balance of payments (BOP) will remain in equilibrium when the sum of its reciprocal demand elasticities of export and import goods exceed one. This condition was first proposed by Alfred Marshall in 1898 and refined by Hans Peter Lerner in 1934. It is closely related to the J-curve theory which states that a countrys balance of payments will initially worsen before improving following a change in the exchange rate.

The Marshall-Lerner condition is based on the established economic principle that global equilibrium can only be achieved if the demand for goods and services is equal to the amout of goods and services supplied in a particular goods market. The Marshall-Lerner condition states that if a country changes its exchange rate, its BOP will improve only if the sum of the elasticities of demand of goods exported from that country and goods imported into that country exceeds one.

In other words, for a change in the exchange rate to improve a countrys BOP, the goods must be relatively elastic. To illustrate this, consider a scenario where a country devalues its currency in a bid to spur exports since the goods will now be cheaper for foreign customers. If this countrys goods are not very elastic and their demand has not increased significantly after the devaluation, then their balance of payments will not improve and they will run a trade deficit.

The Marshall-Lerner condition was largely theoretical until it was tested empirically in 1957 by John Chipman. The results of this study suggested that the Marshall-Lerner condition might not hold in all cases. However, the principle still holds true in many cases and is a useful tool for economists to consider when analyzing the impact of changes in exchange rates on a countrys BOP.