The real exchange rate is , where is the price of domestic goods in terms of foreign goods, is the price of domestic currency in terms of foreign currency, is the domestic price level and the foreign price level. If the Indian Rupee depreciates against the Japanese Yen and the Marshall-Lerner condition holds, then
Answer: (B) and (C)
A rupee depreciation lowers the foreign-currency price of Indian goods, so foreign demand for Indian goods increases, supporting statement (C).
When the Marshall-Lerner condition holds, the sum of the export and import demand elasticities exceeds one, so depreciation improves the trade balance, supporting statement (B). Imports become more expensive and fall, so (A) is wrong, and (D) contradicts (C). The correct statements are (B) and (C).
Depreciation raises the domestic-currency cost of imports, so imports fall rather than rise; the Marshall-Lerner condition is precisely what guarantees the balance improves.
The real exchange rate is e = EP/P^⋆, where e is the price of domestic goods in terms of foreign goods, E is the price of domestic currency in terms of foreign currency, P is the domestic price level and P^⋆ the foreign price level. If the Indian Rupee depreciates against the Japanese Yen and the Marshall-Lerner condition holds, then (A) India's imports will increase. (B) India's trade balance will improve. (C) foreign demand for Indian goods will increase. (D) foreign demand for Indian goods will decrease.
Also written as: The real exchange rate is e = EP/P*, where e is the price of domestic goods in terms of foreign goods, E is the price of domestic currency in terms of foreign currency, P is the domestic price level and P* the foreign price level. If the Indian Rupee depreciates against the Japanese Yen and the Marshall-Lerner condition holds, then
Balance of payments and exchange rates has come up 120 times in 7 exams since 2007.
This question is on Devaluation, the Marshall-Lerner condition and the J-curve, part of Balance of payments and exchange rates in International Economics.
When a fall in the currency improves the trade balance and why it may first worsen it.
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Question from the IIT JAM 2022 paper. Solutions are TestStop's own. Not affiliated with or endorsed by any examination authority.