Question

A real exchange rate of $1.3393 implies that the same market basket of goods sold in the EU is about _______________________ than that sold in the US. (Pus: $112, Peu: €120, and R: $1.25 per €.)

A) 34% more expansive

B) 25% less expansive

C) 17% more expansive

D) none of the above

Answer 1

Solution:

Real exchange rate always takes into consideration the difference in price levels of two economies. In this sense, it measures the purchasing power of same value of currency across different economies.

Thus, if real exchange rate is such that 1 euro = $1.3393, implying that for same consumption basket costing $1 in US, it cost $1.34 (nearly) in EU. So, the same basket is

Higher price percent = ((1.34 - 1)/1)*100 = 34%

34% more expensive. So, correct option is (A).