SELECT * FROM question_mgmt as q WHERE id=5444 AND status=1 SELECT id,question_no,question,chapter FROM question_mgmt as q WHERE courseId=3 AND subId=59 AND chapterId=607 and ex_no='1' AND status=1 ORDER BY CAST(question_no AS UNSIGNED) CBSE Free NCERT Solution of 12th macro-economics Open Economy Macroeconomics distinguish between the nominal exchange rate and

Question:

Distinguish between the nominal exchange rate and the real exchange rate. If you were to decide whether to buy domestic goods or foreign goods, which rate would be more relevant? Explain.

Answer:

Nominal exchange rate is the price of one currency in terms of another. It is the amount of domestic currency required to buy one unit of foreign currency. For example a rupee- dollar exchange rate of Rs 45 means that it costs 45 rupees to buy 1 dollar. Real exchange rate is the ratio of foreign prices to domestic prices. In other words, it measures foreign prices relative to domestic prices.

Real exchange rate

Where Pf - price level of foreign currency

P - Price level of domestic currency
e - Nominal exchange rate

For example, if a watch costs $40 in US and the nominal exchange rate is 50 per US dollar, then, with a real exchange rate of 1, it should cost Rs 2,000 (ePf = 50 × 40 = Rs2000) in India.

If, I were to decide whether to buy domestic goods or foreign goods, then real exchange rate will be more relevant, because real exchange rate takes the inflation differential among the countries into account and is also used as an indicator of a country's competitiveness in the foreign trade.


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