Question

Suppose the nominal exchange rate between the U.S. and the U.K. is: $1 = £0.5. Also, a gallon of milk in the U.S. is $3.50 while a gallon of milk in the U.K. is £2.00. What is the real exchange rate?

Answer 1

$ 1 = 0.56 pounds

Step-by-step explanation:

Converting the cost of a gallon of milk in the UK to US dollars is:

2*2 = 4 US Dollars

The percentage more expensive UK milk is than in the US

= (1 - (price of milk in US/price of milk in UK))*100

= (1- 3.5/4)*100 = 12.5%

So milk in the UK is 12.5% more expensive in the UK than in the US.

Therefore:

The real exchange rate = 0.5*the percentage of milk more expensive in UK + 0.5

1 Dollar = 0.56 Pounds