Marshall-Lerner Condition for Devaluation Success

Steps:

• Devaluation lowers export prices in foreign currency and raises import prices in domestic currency.
• Improvement in current account requires export revenue to rise and import spending to fall in domestic currency.
• This depends on quantity responses to price changes, driven by demand elasticities.
• The net effect is positive if the sum of export demand elasticity and import demand elasticity exceeds one.

Why C is correct:

• C states the Marshall-Lerner condition: |ε_x + ε_m| > 1, where ε_x is foreign demand elasticity for exports and ε_m is domestic demand elasticity for imports, ensuring volume gains outweigh value losses.

Why the others are wrong:

• A: Focuses on supply elasticities, but devaluation effects hinge on demand elasticities for quantity changes.
• B: Incorrectly compares supply and demand elasticities; only demand elasticities matter for trade volumes.
• D: Involves price controls, unrelated to automatic elasticity-driven responses to devaluation.

Final answer: C