1. Factors affecting exports and imports
What happens to UK exports if the pound falls in value against other currencies
UK goods would become cheaper in overseas markets. Demand will rise, and so exports would rise – improving the current account balance
What happens to imports if the pound falls in value against other currencies
Imported products will be more expensive, so demand will fall and so (the volume of) imports will fall
But what happens to the value of imports?
Are there any time lags?

2. Effect on Imports from fall in value of the Pound
Price
Is a+c > b+c (ie is a>b)
Is d+e > e+f (ie is d>f) P2
P2,3
Supply of imports2 d a P1
Supply of imports1
Demand for imports2 e f c b
Demand for imports1 Q3 Q2 Q1
Quantity

3. Marshall Lerner 10% fall in £ PED 0 PED 0.5 PED 1 PED>1
Export volume
+5%
+10%
+>10%
Import volume
-5%
-10%
->10%
Export value
Import value
decrease
Impact on C/A
This is the worst case scenario, exports unchanged but imports rise by 10%
No effect: same increase in the value of both exports and imports
Reasonable
Improvement. Exports increase by 10%, but the value of imports is unchanged
Big improvement – exports rise sharply and imports fall

4. Marshall Lerner Condition
If the PED for exports and imports is low, a depreciation can worsen the trade balance
Which means lower output and higher prices. Not good
If the PED for exports and imports is high, a depreciation will improve the trade balance
Given certain assumptions, such as starting at balance on the trade account, the Marshall Lerner Condition states:
As long as the sum of the price elasticities of demand for imports and demand for exports (in absolute value) is greater than 1, a devaluation/depreciation will improve the trade balance

5. Example of cars
Starting exchange rate is $1.60/£ (each pound buys $1.60)
Assume we export 2 million cars at £10,000 each, and import 2 million cars at $16,000 each (equivalent to £10,000)
What is the value of exports and imports?
£20 billion each
Let us assume the pound falls in value (depreciates) by 5%, from $1.60 to $1.52
What do we need to know to work out what happens to the value of exports and imports?
PED for exports and PED for imports
Assume the price elasticity for both is What happens to the value of exports and imports
Exports rise to £20.2 billion
Imports rise to £20.83 billion, so trade balance worsens
Assume price elasticity is -0.7 for each. What happens now?
Exports rise to £20.7 billion, imports rise to £20.28 billion; trade balance improves
Price elasticity is -1.2 for each. What happens?
Exports rise to £21.2 billion, imports fall to £19.72 billion; trade balance improves dramatically, by $2.4 billion

6. J Curve
Are there any time lags involved if a currency falls in value (depreciates)?
2 time lags:
In the short term contracts will have been agreed, so the new exchange rate will not apply to all exports and imports. Some will keep existing prices for a while
Demand takes time to adjust to new prices. Consumer will not instantly switch from say BMW made overseas to a Jaguar made in the UK
Can we think of this in terms of elasticity?
Yes, elasticity increases over time

7. J curve