Cambridge International as and a level Economics Ebook

1
What type of exchange rate system does China 
operate?
2
What does the information suggest about China’s 
infl ation rate compared with those of the US and 
Japan in 2013?
3
Explain why a shortage of workers could result in 
a rise in a country’s real exchange rate.
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Chapter 4: The macroeconomy 
imported raw materials will rise. Domestic fi rms may 
also feel less competitive pressure to keep costs and 
prices low.
It is oft en expected that a lower exchange rate will 
reduce a current account defi cit. Th
is, however, is not 
always the case. Th
e outcome will depend, in part, 
on the price elasticities of demand for both exports 
and imports. If demand for exports is price elastic 
and demand for imports is price elastic, a fall in the 
exchange rate will clearly result in a rise in export 
revenue and a reduction in import expenditure. Th
ese 
changes will reduce a current account defi cit. What is 
sometimes not realised is that if the combined price 
elasticities of demand for exports and imports are 
greater than 1, a 
depreciation
or 
devaluation
will 
improve the current account position. For instance, 
PED of exports might be 0 while PED of imports is 
–1.2. In this case, a fall in the exchange rate will result 
in export revenue remaining unchanged in terms of the 
home currency while import expenditure will fall. Th
is 
requirement for the combined elasticities to exceed 1 
for the current account position to be improved by a fall 
in the exchange rate is known as the 
Marshall-Lerner 
condition
. Th
e box item uses simplifi ed fi gures to 
illustrate this condition.