Question

Suppose it takes $1.05 to buy 1 euro, the U.S. price level is 120, and the European price level is 125. A. Calculate the real exchange rate for the U.S. against the euro.B. Suppose the U.S. price level rises to 130. Calculate the real exchange rate again and explain why it has risen or fallen.

Answer 1

0.914

0.990

Step-by-step explanation:

Real Exchange rate= e * P/P

where

e = nominal exchange rate

P = Domestic Price Level

P* = Domestic Price Level

On that basis, we calculate that

a.)

$1/$1.05 = 0.9523

0.9523 * 120/125 =

0.9523 * 0.96 =

0.914

b)

$1/$1.05 = 0.9523

0.9523 * 130/125 =

0.9523 * 1.04 =

0.990

Also, there is going to be a change in the domestic price level. This change will then go on to affect the real exchange rate