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Theoriesof
devaluation
INTERNATIONAL TRADETopic-6
The elasticity approach,Marshall Lerner condition,J.curve
,absorption approach and exp switching policy.
.DEVALUEATION THEORIES
5.Expenditure
switching policy
4.The
absorption
approach
1.The
elasticity
approach
2.Marshall
Lerner
condition
3.J.curve
effect
1.The elasticity approach
This approach also known as- Lerner and
Marshall approach.
Acc. To them – devaluation can be improve BOP deficit
by price elasticity of demand and supply of imports and
export of devaluating country.
1..If demand for export of devaluing country is less than
unity, then
Devaluation will not reduce Bop Deficit.
On the side of export
2..elasticity of export more than unity
Devaluation bring reduction in BoP deficit.
Raise the volume of export.
On the side of import
1. Elasticity for import is more than one. (EM>1).
Devaluation will lead to improve in BoP.
Due to devaluation import prices may increase and it will
lead to decrease in import.(BOP improved)
Import payment reduce than before.
2..if elasticity for import is less elastic(EM<1)
Devaluation will lead to Worsened in BoP.
After devaluation net increase in payment.
2.Marshall- Lerner conditions
According to Marshall and Lerner devaluation can
improve both – BOP and BOT.
M-L condition based on three aspects.
1. If sum of the elasticity of demand for export and
import is greater than unity devaluation will improve the
BOP.
ED>1- BOP improve.
2. If sum of the elasticity of demand for export and
import is less than unity devaluation will woresening the
BOP.
ED<1- BOP worsening.
3. If sum of the elasticity of demand for export and
import is equal to unity devaluation will unchanged in
BOP.
ED=1- BOP unchanged.
According to Marshall and Lerner EX and EM are
perfectly elastic(horizontal)
In M-L theory conditions are analysis in term of the
currency of devaluation country or in terms of foreign
currency but not in terms of both.
The net change in Bop due to change in rate of exchange
has been expressed by - Metzler
3. The J-Curve effect
The J-Curve shows devaluation worsening the BoP in
short run and improve BOP in long run due to
devaluation.
J-Curve introduced by- S.P.Magee
0
su
rplu
sd
efi
cit
T
Time
In the short run devaluation make import costly ,
So,, large payment for import.- therefore BoP worsening.
4.The absorption approach.
This approach given by- Sydeney Alexander
Acc. To him devaluation can effect domestic consumption
,investment and govt spending.
State of eqm= C+I+G(X-M)
The aggregate domestic spending is (C+I+G)
It is called absorption(expenditure).
Sum of a and b is called marginal propensity to
absorption.
e= a+b
Larger the value of e, lower the success of devaluation .
There are three possibilities.
If e<1 – improve the trade balance.
If e=1 – neither improve nor worsening trade balance.
If e>1 –worsening the trade balance.
Acc.to Alexander- to reduce absorption govt should
adopt – expenditure reducing policy.
5,Expenditure switching policy
Given by H.G .Johnson
It means switching expenditure from foreign produced
goods to home produced goods.
Due to it – marginal propensity to spend will be less than
unity . It will bring improve in BOP.
Acc.to him – devaluation swithes both expenditure ie
foreign and domestic toward domestic production..
Devaluation and its effect taken in partial eqm analysis.
It doesn’t adopt cut in expenditure..
This policy also implies export promotion..
This theory assume that export will be unaffected.
Acc. To Keynes adjustment in BOP is possible through-
income
Acc. To classical adjustment in BOP is possible through-
deflation and exchange depreciation.
Acc. To modern economist. adjustment in BOP is
possible through- income, output, and expenditure.
Foreign .. exchange..
INTERNATIONAL TRADETopic-7
Spot rate, forward exchange rate, currency swap,
speculation, hedging and some imp points