I’m currently having a difficulty understanding the J-curve (pg 235 of Schweser book 5) They mentioned that in the short run, trade balance widens due to an increase in the cost of imports, but why does the chart show the line declining first and then increasing after?
In the short run, the devaluation of the currency will make it more expensive to import products (you are paying more of your currency to buy one of the foreign currency) In the long run, the exporting of less costly products increaces your balance of trade and should balance the deficit created by the short run affect. It is assumed that countries export more than they import and that the import affect is Immediate.
Look at the labels on the axis. I thought J curve was for employment levels (from level 1).
I think my problem is a bit more fundamental, the reason why the chart declined first is because import becomes bigger? (thus export minus import declines, as the chart indicates)
That means widening of trade gap equates to a larger increase in imports than exports right? My problem understanding this is because I thought imports would decline since it is more expensive to do so
Ipad, there is an assumption underlying the J-curve that has not been accounted for here : Volume of exports and imports do not change immediately subsequent to a currrency devaluation. Let’s see how this changes things
Net Exports=Value of exports-Value of imports
where Value of exports (imports) = Price of exports (imports)*Quantitiy of exports (imports)
Now suppose that we are at the beginning of the curve and the currency depreciates:
In the Short term:
- Price of imports increases because we need more units of domestic currency to receive a unit of foreign currency
- Quantity of imports/exports do not change in the short term (e.g.trade contracts)
- Value of imports increases because we are mulltiplying a higher price with the same amount of quantity as before
- Net exports or trade balance may decline initially because value of exports < value of imports
In the medium to long term:
- Quantity of exports starts to rise
- Quantity of imports starts to fall
- Value of exports > value of imports
Right the immediate technical effect of the J-curve is not a quantity adjustment but a price adjustment.
This helps a lot! understand 100% of it now.
thanks a bunch guys =D
Wasn’t this also in L1?
it probably is, but i took that 2 yrs ago so it’s kinda blurry