Marshall-Lerner Condition/J-Curve

J-Curve

A country's trade balance experiences the J-curve effect if its currency becomes devalued. At first, the country's total value of imports exceeds its total value of exports, resulting in a trade deficit. Immediately following the depreciation or devaluation of the currency, the volume of imports and exports may remain largely unchanged due in part to pre-existing trade contracts that have to be honoured. Moreover, in the short run, demand for the more expensive imports (and demand for exports, as they are cheaper to foreign buyers using foreign currencies) remain price inelastic. This is due to time lags in the consumer's search for acceptable, cheaper alternatives (which might not exist).

Over the longer term a depreciation in the exchange rate can have the desired effect of improving the current account balance. Domestic consumers might switch their expenditure to domestic products instead of expensive imported goods and services, assuming equivalent domestic alternatives exist. Equally, many foreign consumers may switch to purchasing the products being exported into their country, as with a their currency they will be able to buy them cheaper. Therefore as the currency devaluation reduces the price of a country's exports, it consequently brings the country's level of exports to gradually recover, and the country moves back to a trade surplus. 

*A J-curve is called so due to it's shape, starting out as a fall that is followed by a rise.

If we look more at this graph we can see that X is the point where the currency got depreciated. The segment from X to Y is where PED is inelastic, and not much in the market changes therefore the current account balance still worsens. But starting from Y to point Z the PED becomes elastic, meaning as longer time has passed people have started switching from using expensive imports to domestic goods. As well as other countries have started buying more of this country's exports as they are cheaper to buy with foreign currency. Leading to the CAB get back to the surplus.

* http://www.dineshbakshi.com/ib-economics/international-economics/157-revision-notes/2139-marshall-lerner-condition-and-j-curve
* http://www.econclassroom.com/?p=2821 

Marhsall-Lerner condition

Fewer imports and more exports doesn't necessarily mean an improvement in the country’s balance of trade. What matters is whether the increase in income from exports exceeds the decrease in expenditures on imports. The Marshall-Lerner condition examines the price elasticities of demand for exports and imports of a particular country. 

The condition tries to answer the question: when does a devaluation or a depreciation of a currency improve the current-account balance of a country?

The Marshall-Lerner condition states that a devaluation or a depreciation of the currency will improve the CAB if the sum of the elasticities (in absolute values) of the demand for imports and exports is greater than one,

ExportsPED + ImportsPED > 1

For example: if UK experiences a depreciation of its currency it means it is more expensive for them to import goods, yet their exports will be cheaper for other countries to buy. Therefore logically there will be less import than before and more export. If foreigners’ demand for exports from UK is relatively elastic, a slight weakening of the pound should cause an increase in foreign demand, which can but doesn't have to cause the export income for UK to rise rapidly. As well as, if UK's demand for imports is highly price elastic, then a slightly weaker pound should likewise cause UK’s demand for imports to decrease, which can in turn reduce UK's expenditures on imports.

(Yet once again doesn't have to, if it's really expensive to import yet demand hasn't fallen that much we might spend just the same amount on imports. This all depends on the elasticities of the demand.) Therefore this is where the M-L condition comes to play: If the combined elasticities of demand for exports and imports is elastic (the coefficient is greater than 1), then a depreciation of a nations currency will shift its current account balance towards surplus, and vice-versa. 

Euro-zone country:  Netherlands

Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).

Dutch current account surplus decreased to 16501.30 EUR Million (10 percent of GDP) in the second quarter of 2015, compared to a 17686.6 surplus a year earlier, due to a lower surplus of primary income. While Dutch businesses distributed higher dividends to foreign shareholders than a year ago, Dutch investors received lower dividends on the equity and shares they hold. Meanwhile, the trade balance was at a similar level when compared to the second quarter of last year. Even though the trade balance surplus was bigger for 2015 July it was for 2014 July, the Dutch current account surplus decreased. Reason for that;

Over the past year the value of euro has fallen quite a bit in comparison to other currencies especially to U.S dollar. From July 2014, 1.3715 U.S dollars = 1 euro to July 2015 when 1.1058 = 1 euro.
Therefore when the Dutch shareholders had to pay their dividends to someone who's company uses U.S dollars they had to pay more in euros this year than they had to last year. for example if their dividend last year in July was 1000 dollars then they only had to pay 729.12 euros to them, yet the 1000 dollars this year means they had to pay 904.32 euros. When it comes to bigger numbers this difference will be more significant as there is a 24% increase in the amount they have to pay this year! That also means that this year they technically also receive 24% less in dividends (when paid in U.S dollars.)
Therefore Netherlands received less income in 2015 July than it did in 2014 July, and this loss was bigger than the increase in the trade balance therefore it caused a decrease in the current account surplus.

http://www.tradingeconomics.com/netherlands/current-account