Marshall-Lerner Condition and Trade Elasticities

Steps:

• Depreciation makes exports cheaper and imports costlier, potentially boosting net exports.
• Improvement in trade balance depends on elasticities of demand for exports and imports.
• Marshall-Lerner condition states that devaluation improves trade balance if sum of elasticities exceeds 1.
• If sum is less than 1, depreciation worsens the deficit initially.

Why B is correct:

• Marshall-Lerner condition requires sum of price elasticities >1 for depreciation to improve trade balance; if <1, quantity responses are insufficient, worsening the deficit.

Why the others are wrong:

• A: Unused resources allow supply expansion, enhancing export response to depreciation.
• C: Long-run elasticity increase satisfies Marshall-Lerner, improving trade balance over time.
• D: Low import use in production limits cost pass-through, strengthening depreciation's positive effects.

Final answer: B