What is J-curve effect? Explain it graphically.
The J-curve effect explains how a country’s trade balance responds to a currency devaluation.
Initial Deterioration: In the short run, import and export quantities remain rigid due to contracts, habits, and production lags. Since imports become costlier in local currency, their value rises sharply, while export volumes do not adjust immediately. As a result, the trade deficit worsens or the surplus shrinks. This forms the downward hook of the “J.”
Subsequent Improvement: Over time, demand responds to new relative prices. Cheaper exports boost foreign demand, while expensive imports are reduced or substituted with domestic goods. As export earnings rise and import expenditure falls, the trade balance improves, eventually surpassing the initial level. This creates the upward slope of the “J.”
Graph: The curve starts near balance, drops to a trough (Point A), then gradually recovers (Point B) and rises above the starting point (Point C), forming a “J” shape over time.
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