Answer to Question #257055 in Microeconomics for edward

Question

Discuss the Elasticity Approach to the Balance of payment adjustment.Futher,indicate why the elasticity approach is not an ideal approach in explaining the balance of payment adjustment.

Answer 1

The balance of payments is a report on a country's international transactions over a set period of time, usually a quarter or year. It displays the total value of all transactions between individuals, businesses, and government agencies in that country and those in other countries, both purely financial and those including products or services.

A credit and a debit are generated by every foreign transaction. Credits are transactions that bring money into a country, whereas debits are transactions that take money out.

The current account, the capital account, and the finance account are the three accounts that make up the BOP statement. The current account accounts for foreign trade in products and services, as well as investment earnings. Capital transfers and the acquisition and sale of non-produced, non-financial assets are all included in the capital account. Financial capital and non-financial capital transfers are recorded in this account. Sub-accounts are separated from the main accounts.

The elasticity technique attempts to forecast the effects of policy changes on the balance of payments. This method, for example, shows how exchange rates affect the balance. Devaluation can also enhance the balance of payments if the BOP is in equilibrium, according to the elasticity approach. Devaluation, on the other hand, requires an increase in the total price elasticity of local and international demand for imports. Under ideal conditions, a country's balance of payments improves when it devalues its currency. The Marshall-Lerner condition refers to this ideal state.

The Marshall-Lerner elasticity technique suffers from the following flaws:

1. Deceitful:

The Marshall-Lerner concept of elasticity is used to solve the bop deficit in the elasticity approach. This is due to the fact that it only applies to incremental changes along a demand or supply curve, as well as problems involving curve shifts. Furthermore, it is based on the assumption that money has a constant purchase value, which is irrelevant in the case of currency depreciation.

2. Elasticity of supplies isn't ideal:

The Marshall-Lerner assumption is that export and import supply are completely elastic. However, this assumption is unreasonable because the country may not be able to increase the supply of its exports when the value of its currency depreciates, making them more affordable.

Partial Equilibrium Analysis (PEA) is a technique for determining whether or not something is in

Within the devaluation country, the elasticity method assumes steady domestic price and income levels. It also presupposes that using additional resources in production for exports is not restricted. This analysis is based on partial equilibrium analysis, as these assumptions demonstrate.

4. Inflationary: Inflationary pressures in the economy can be exacerbated by depreciation. Even if it succeeds in improving the balance of payments, export and import-competing businesses are likely to see a rise in domestic income. However, these higher wages will have an impact on the bop both directly and indirectly by increasing demand for imports and so raising prices within the country.