## >International Finance and the Balance of Payments

>This is a discussion aimed to help people learn rather than a debate. So if you have any questions about this topic put them forward and hopefully someone will answer them correctly.

• >Ok my first question is about the Marshall-Lerner Condition proposed by the Elasticities Approach to the Balance of Payments.One explanation of this is that: "devaluation will cause the current account to move toward a surplus if the sum of the country's elasticity of demand for imports and foreign demand for the country's exports is greater than unity." (from CEFIMs, University of London course notes, pg 8 of Int Finance notes).The main problem is I don't really understand the phrase "greater than unity". I looked it up on the internet and found that it meant "greater than 1". But to be honest this doesn't clear up a great amount for me.Could anyone explain this and give an example of the Marshall Lerner Condition?

• >Actually I'm thinking the word 'unity' may perhaps mean a ratio of 1 to 1. So it's saying that if the ratio of change(%) in foreign demand for exports exceeds the perecentage change in demand for imports (assuming both are positive changes) then there will be a surplus. Basically it could just be said by saying if exports are greater than imports there will be a surplus in the current accounts. That seems so simple it doesn't even warrant being said. Could anyone verify this for me? Maybe I'm wrong.

• >ok i did do that wrong. Elasticity is the ratio of a percentage change in one variable to the percentage change in another. Hence the price elasticty of demand for imports equals:The percentage change in volume of imports divided by the percentage change in price.And the price elasticity of demand for exports equals:The percentage change in volume of exports divided by the percentage change in price.We take the 2 numbers (price elasticity of demand for imports and exports) and add them together. If the resulting number is less than one it is said to be less than unity, at one, unity, and greater than one greater than unity. For example if devaluation resulted in a change of volume of 0.3% imports, and 0.25% exports; and a change of 0.33% import price and 0.33% export price then we would do the following sum:0.3/0.33=0.90.25/0.33=0.750.9+0.75=1.65Our resulting number (1.65) is greater than one and hence greater than unity. This means that the case succesfully fulfils the Marshall-Lerner condition for a succesful devaluation.

• >The elasticity approach is called the relative prices approach because it is focussed on how a change in the exchange rate alters the relative prices of domestic and foreign goods and services. How this affects the balance of payments depends on how consumers react to the changes. This is what is measured by the price elsticity of demand. Following a devaluation, or any fall in the exchange rate, exports are cheaper and imports more expensive. The more exports rise (the greater their price elasticity of demand) the bigger the improvement in the BofPs. Similarly if the demand for imports falls a lot (again showing a lrage price elasticity, the BofP will improve. The problem is that if the demand for imports does not fall very much (if price elasticity of demand is less than one), although the quantity of imports must fall, there value will increase, worsening the BofP. The mathematics is such that if the combined elasticities exceed one then the BofP will improve. I think this is what you recognise.Richard

• >Whenever i see the post like your's i feel that there are still helpful people who share information for the help of others, it must be helpful for other's. thanx and good job.Finance Dissertation Proposal