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).

Real Exchange Rate = e (Pf / P)


Where –


e = Nominal Exchange Rate = 1/1.25 = 0.8


Pf =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


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