Suppose the current U.S.UK exchange rate is 0.63 pounds (the pound is the UK cur

Question

Suppose the current U.S.UK exchange rate is 0.63 pounds (the pound is the UK currency) per dollar, and the aggregate price level is 170 for the U.S. and 140 for the UK.

a. What is the real exchange rate?

     Instructions: Round your answer to three decimal places.

__ pounds per dollar.

b. What does this real exchange rate mean in terms of the relative purchasing power of the dollar and the pound?

The U.S. dollar buys more “stuff” in the UK than it would in the U.S. The U.S. dollar buys less “stuff” in the UK than it would in the U.S. The U.S. dollar buys the same amount of "stuff" in the U.S. as it would in the UK.

Explanation / Answer

Real exchange rate = nominal exchange rate * (prices abroad/domestic prices).

Nominal exchange rate, $1 = 0.63 pounds.

RER = 0.63 * 170/140.

RER = 0.765.

Option B is correct. From the RER calculated it is clear that dollars would buy less goods in UK.

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