BT (x-m) depends on the 
price competitiveness (ø)


Real and nominal 
exchange rates : our 
imports and exports are 
influenced by nominal 
exchange rate and the real
exchange rate = price 
competitiveness = ø

ø = price of foreign 
goods expressed in our
home currency / price of
home goods

ø = P*e / P            

with e = nominal exchange 
rate (EUR/USD : 
  home currency/ 
  foreign currency = 
  units of home currency
  needed to purchase one
  unit of foreign currency) 

increased ø (real exchange 
rate depreciates)= 
price of foreign goods 
are more expensive than
our home goods = 
decreased imports, 
increased exports = 
improve of BT = higher Y 
(income = GDP) = shift IS
curve to the right

ø decreased (real exchange
rate appreciates) = 
price of foreign goods 
are cheaper than our home
goods = imports will 
increased and exports 
will decreased = deterioration
of BT (x-m) = lower Y
(income = GDP) = shift 
IS curve to the left


If e increased = more units
of home currency needed 
to purchase one unit of 
foreign currency = home 
currency depreciates 
(flexible exchange rate), 
devaluates (fixed exchange
rate)

If e decreased = few units 
of home currency are needed
to purchase one unit of 
foreign currency = home 
currency appreciates / 
revaluates

Marshall Lerner condition =
as long as the sum of the 
price elasticity of demand
for exports and the price 
elasticity of demand for 
imports exceeds one, 
depreciation (increased ø)
improve BT

Marshall Lerner condition
is satisfied if :

volume effects dominate price 
effects
An increase of real exchange 
rate (ø) improves BT = increase
of y

If price effects 
dominates volume effects, 
a depreciation of real
exchange rate (increase of ø)
will leads to deterioration
of the trade balance (BT)