J-Curve Effect from Low Price Elasticities

Steps:

• Currency depreciation raises import prices and lowers export prices in domestic terms.
• If price elasticities are low (inelastic demand), import volumes fall little but values rise, while export volumes rise little, worsening the current account initially (X as deeper deficit).
• Over time, quantities adjust as consumers switch, leading to net improvement (Y as surplus).
• Low combined price elasticity (<1) explains the delayed positive shift shown over time.

Why C is correct:

• Marshall-Lerner condition requires sum of price elasticities >1 for improvement; 0.2 (<1) causes short-run worsening then long-run gain via J-curve.

Why the others are wrong:

• A: Income elasticity affects trade response to GDP changes, not price effects of depreciation.
• B: Elasticity of 2.0 (>1) would cause immediate surplus, not delayed movement over time.
• D: Income elasticity of 0.2 is irrelevant to depreciation's price mechanism.

Final answer: C