Final answer:
When the real exchange rate increases, it makes a country's exports more expensive and imports cheaper, leading to a decrease in the trade balance.
Step-by-step explanation:
When the real exchange rate increases, it means that the country's currency has appreciated in value compared to other currencies. This has an impact on the balance of trade, which refers to the difference between a country's exports and imports.
When the real exchange rate increases, it makes the country's exports more expensive for foreign buyers, while making imports cheaper for domestic consumers. As a result, the value of exports may decrease, while the value of imports may increase. This leads to a decrease in the trade balance, typically resulting in a trade deficit.
For example, if the real exchange rate of the U.S. dollar increases, it makes U.S. exports more expensive for foreign buyers, potentially causing a decline in exports. At the same time, the stronger dollar makes imported goods cheaper for U.S. consumers, leading to an increase in imports. This combination can result in a larger trade deficit for the U.S.