Absorption approach is able to avoid several restrictive assumptions which had to be made by the elasticity’s approach. It highlights the truth that the effect of devaluation on balance of trade depends upon a complex interaction of several forces. It enables us to split up the analysis of the effect of devaluation on trade balance into parts, and then add them up.
1. In discussing the ‘absolute-price-level effect’, Alexander assumes that domestic money supply remains unchanged when balance of trade is shifting. This is almost never so. Even he himself admits the possibility of variation in money supply in response to changes in prices of imports and exports. An increase in money supply can induce money-holders to increase their expenditure and thus worsen balance of trade.
2. Fritz Machlup and others point out that the price changes caused by devaluation may themselves alter the propensity of the devaluing country to absorb.’
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3. Absorption approach plays down the role of elasticities. When prices of imports and exports change due to devaluation, the change in their demand and supply would be determined by their respective elasticities. Interaction between prices, elasticities, demands and supplies is a continuous and unending process.
4. Absorption approach bases part of its reasoning on the assumption that devaluation worsens terms of trade against the home country. But it need not be so. This outcome depends upon the values off our elasticities, viz., those of remixed and supply for both imports and exports of the home country. For example, the terms of trade of the devaluing country will worsen if the demand elasticities are low relative to the supply elasticities.