Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).

Question

Philoid · Accepted Answer

Real Exchange Rate = e (P_f / P)

Where –

e = Nominal Exchange Rate = 1/1.25 = 0.8

P_f =Price level of foreign currency = 3

P = Price level of domestic currency = 1.2

For given example of potatoes the real exchange rate will be –

= 0.8 (3 / 1.20)

= 2