Marshall-Lerner Condition for Devaluation Success

Steps:

• Devaluation lowers export prices abroad and raises import prices domestically, aiming to boost exports and cut imports.
• For net export volume to rise and improve the current account, quantity responses must outweigh price effects.
• This requires elastic demand: export demand elasticity (ηx) measures foreign response to cheaper exports; import demand elasticity (ηm) measures domestic response to costlier imports.
• The trade balance improves if ηx + ηm > 1, per the Marshall-Lerner condition.

Why C is correct:

• The Marshall-Lerner condition states that devaluation improves the trade balance only if the sum of export and import demand elasticities exceeds 1, ensuring volume gains exceed value losses.

Why the others are wrong:

• A: Tariffs and subsidies are trade policies unrelated to devaluation's direct price elasticity effects.
• B: Both elasticities >1 is sufficient but not necessary; the sum >1 allows one to be <1 if the other compensates.
• D: Higher domestic inflation erodes devaluation benefits over time but is not required for the initial current account improvement.

Final answer: C