The Marshall Lerner condition and the J curve made sense until one day I noticed that to make sense of all of this , we considered two different currencies. I was told for e.g. in the short run, export revenue would deteriorate since demand would be inelastic. But prices for exports only fell for the foreign buyer, not for domestic firms. If quantity being sold rose even by little, won't revenue earned by local producers have increased? Similarly, we considered effect on imports but this time considering domestic currency. My question is that when we look at trade balance , which currency do we use for analysis.
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My reading of the Marshall-Lerner condition is that it assumes the price of exports is constant in the domestic currency and the price of imports is constant in the foreign currency. Analysis is conventionally done in the domestic currency
But, initially after devaluation, volumes are assumed to stay the same (short-term inelasticity) and measured in the domestic currency the values of exports stays the same while the value of imports rises, leading to a deterioration in the measured trade balance; this is the immediate cost effect of devaluation. If you were to measure in the foreign currency, the short-term value of exports would fall while the short-term value of imports would stay the same, again leading to a deterioration in the measured trade balance
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$\begingroup$ Would the same logic apply to terms of trade ? That we conventionally deal in the domestic currency but picking either won't effect result? $\endgroup$– Sal_99Commented May 2, 2018 at 14:25
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$\begingroup$ The terms of trade are measured in the domestic currency, typically dividing an export price index by an import price index. It would not change if you converted both indices by the same exchange rate, or by the same trade-weighted effective exchange rate to take account of multiple trading partners $\endgroup$– HenryCommented May 2, 2018 at 21:13
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