Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

 
This condition is known as Marshall-Lerner condition. 
2. Devaluation : The absorption approach; 
It runs through the income effect of devaluation as against 
the price effect of the elasticity approach. The theory states that if a 
nation has a deficit in the balance of payments. It means that 
people are absorbing more than they produce. The analysis can be 
explained in the following form: 

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Y = C+Id+X-M 
Where, 
Y is national income 
C is consumption expenditure 
Id is total domestic investment 
X represents exports and
M imports. 
The sum of C+Id is the total absorption designated as A, the 
balance of Payment (X-M) is designated as B. thus, 
Y = A+B or B = Y-A 
This means, balance of payment is the difference between 
national income and total absorption (consumption + investment).
Devaluation helps in increasing the national income. The additional 
income so generated will further increase income via the multiplier 
effect. This will lead to an increase in domestic consumption. This 
the net effect of the increase in national income on the balance 
payments is the difference between the total increase in income 
and the induced increase in absorption.
∆B = ∆Y- ∆A 
This difference between Y and A is called the real 
hoarding. Thus the effect on the balance of payments of the 
increase in income due to devaluation is equal to the real hoarding 
the economy. So an improvement in the BOP can be brought 
about a by reduction in absorption.
 
Check your progress: 
 
1) What is absorption approach?