Question

If the nominal exchange rate is 1.5 New Zealand dollars per U.S dollar, the price of...

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

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Answer #1

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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