Question

1. a Suppose the nominal exchange rate between the US dollar and the Canadian dollar is 1.25 (1 US dollar can buy 1.25 Canadian dollars).

If the price of a basket of goods in the USA is 150 USD and in Canada is 175 CAD, then find out the real exchange rate between the USA and Canada.

1. b Interpret the value of the real exchange rate you found in 1. a

2.  Again suppose the nominal exchange rate between the US dollar and the Canadian dollar is 1.25 (1 US dollar can buy 1.25 Canadian dollars).

Let the Purchasing Power Parity condition between the USA and Canada holds true. If the price of a FORD SUV is USD 35,000.00 in the USA, then find out the price of the FORD SUV in Canada in terms of Canadian dollar

Answer 1

Nominal exchange rate = 1.25 Canadian dollar/ US $

Pusa = 150 USD

Pcad = 175

Real exchange rate = Nominal exchange rate * Pusa/Pcad

Real exchange rate = 1.25*(150/175) = 1.071429 Canadian dollar/ US $

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Consider Purchasing power parity exists.Real exchange rate is 1 under purchasing power parity

Real exchange rate = Nominal exchange rate * Pusa/Pcad

1 = 1.25*35000/Pcad

Pcad = 43750 Canadian dollar

Hence, the price of the FORD SUV in Canada in terms of Canadian dollar is 43750 Canadian dollar