If the nominal exchange rate is 1.5 New Zealand dollars per U.S dollar, the price of apples is $3 per pound in the U.S. and 6 New Zealand dollar per pound in New Zealand, what is the real exchange rate?
The next month all variables remain the same, but the price of apples jumps to $8 per pound.
Which of the following is true?
US real exchange rate decreases; net exports increase
US real exchange rate decreases; net exports decrease
US real exchange rate increases; net exports increase
US real exchange rate increases; net exports decrease
Nominal exchange rate is 1.5New Zealand per dollar.
Price of apple in U.S. = $3
Price of apple in New Zealand = 6 NZ Dollar
Real Exchange rate is calculated as: [Nominal Exchange rate * (Domestic Price / Foreign Price)]
Real Exchange rate = [1.5 * (3 / 6)] = 0.75
If price of jumps to $8 per pound,
Real exchange rate would be = [1.5 * (8 / 6)] = 1.66
A rise in domestic price will raise the real exchange rate. It will make price of apple more in US than in New Zealand which will reduce the net exports.
Option D is correct.
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