An explicit partial‐equilibrium model to justify the Generalized Marshall‐Lerner condition (GML)

Abstract

AbstractRobinson's derivation of the Marshall‐Lerner condition (ML) is more general in that she considers a situation where initially the trade balance is not in equilibrium with the incorporation of the supply curves of exporters. This paper examines a partial equilibrium analysis of a country's imports and exports markets within a theoretical model which considers both the demand and supply sides in these two internationally traded‐goods markets. The aim here is to show explicitly how the Generalized Marshall‐Lerner condition (GML) of Robinson can be obtained. We examined the two effects of the nominal depreciation of the domestic currency on the trade balance: the volume effect and the value effect and how they counterbalance each other. We found that the standard Marshall‐Lerner condition (ML) was not sufficient when the trade balance was initially in deficit and it was also not necessary if the trade balance showed an initial surplus. Moreover, this study provides a new interpretation for Robinson’ sufficiency condition where the trade balance must improve following a nominal depreciation of domestic currency when the elasticity of foreign demand exceeds the ratio of imports to exports. This paper also examines the situation of a small open economy which could not influence the world prices where the foreign demand for exports and the foreign supply of exports are infinitely large. Finally, there is a discussion on two policy implications for exchange rate regulation: the amount of devaluation that is necessary to improve a given trade imbalance as a governments intervention and additional support for the slow improvement of the trade balance in the short run after a devaluation policy known as the J‐Curve effect.