Question

Consider a basket of consumer goods that costs $72 in the United States. The same basket of goods costs MXN 224 in Mexico.

Holding constant the cost of the basket in each country, compute the real exchange rates that would result from the two nominal exchange rates in the following table.

Cost of Basket in U.S.	Cost of Basket in Mexico	Nominal Exchange Rate	Real Exchange Rate
(Dollars)	(Pesos)	(Pesos per dollar)	(Baskets of Mexican goods per basket of U.S. goods)
72	224	14.00
72	224	28.00

Answer 1

Case I - Nominal exchange rate is 14 Pesos per dollar

Cost of basket in Mexico (in Pesos) = 224 Pesos

Nominal exchange rate is 14 Pesos per dollar.

Cost of basket in Mexico (in dollars) = 224/14 = 16

Real exchange rate = Cost of basket in US/Cpst of basket in Mexico(in dollars) = $72/$16 = 4.50

The Real Exchange rate is 4.50

Case II - Nominal exchange rate is 28 Pesos per dollar

Cost of basket in Mexico (in Pesos) = 224 Pesos

Nominal exchange rate is 28 Pesos per dollar.

Cost of basket in Mexico (in dollars) = 224/28 = 8

Real exchange rate = Cost of basket in US/Cpst of basket in Mexico(in dollars) = $72/$8 = 9

The Real Exchange rate is 9.