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Suppose the inflation rate in country A is 4%, the inflation rate in country B is...

Suppose the inflation rate in country A is 4%, the inflation rate in country B is 3% and the exchange rate, expressed as S(B/A), depreciated by 2%. According to the real exchange rate, which of the following is true?

The competitiveness of Country A has improved by about 1%.

The competitiveness of Country B has improved by about 1%.

The competitiveness of Country A has improved by about 3%.

The competitiveness of Country B has improved by about 3%.

None of the other answers.

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Answer #1

Assume Country A is USA

Country B is UK  

Assume S(B/A):=0.8Pound/USD

Inflation rate in Country A(USA) is 4% and inflation rate in country B(UK) is 3%

After one year : S(B/A) depreciated by 2%

This means actual exchange rate after one year =0.8*(1-0.02)Pound/USD

0.784 Pound/USD

The exchange rate should be :

0.8*1.03 Pound per 1.04USD

((0.8*1.03)/1.04 )Pound /USD

0.792308 Pound /USD

This means that Pound has appreciated by 1%

You need to pay less Pound to buy USD

Competiveness of Country B has improved.

Exchange rate has depreciated by 2% , whereas it should have depreciated by 1%

The competitiveness of Country B has improved by about 1%

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