Question

If the exchange rate is 1.25 New Zealand dollars per U.S dollar, the price of apples is $2 a pound in the U.S. and 1 New Zealand dollar per pound in New Zealand, what is the real exchange rate?

A. 22.5

B. 1.25

C. 2

D. 0.75

Answer 1

Answer:

0.75

Explanation:

Given that

Exchange rate of NZ dollar to US dollar = 1.25

A pound of apple in US = 2

A pound of apple in NZ = 1

Recall that

Real exchange rate = nominal exchange rate × (domestic price of item ÷ foreign price of item)

= 1.5 × (1 ÷ 2)

= 1.5 × 0.5

= 0.75

Hence, real exchange rate = 0.75

Answer 2

Based on the price levels in both countries and the nominal exchange rate, the real exchange rate must be 2.50

The real exchange rate is calculated as:

= Nominal exchange rate x U.S. price level / New Zealand price level

Solving would give:

= 1.25 x 2 / 1

= 2.50

In conclusion, the real exchange rate must be 2.50

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