Suppose that a bushel of wheat costs $5 in Canada and costs 40 pesos in Mexico. If the nominal exchange rate is 20 pesos per dollar, what is the real exchange rate?
A) .04
B) 2
C) 2.5
D) 8

Question

Quizplus · Accepted Answer

To calculate the real exchange rate, we need to compare the prices of the same basket of goods in different countries. Here, the basket of goods is a bushel of wheat, which costs $5 in Canada and 40 pesos in Mexico.

To bring the Mexican price into dollars, we need to use the nominal exchange rate, which is 20 pesos per dollar. So, the Mexican price in dollars is:

40 pesos × (1 dollar / 20 pesos) = $2

Now, we can compare the prices of wheat in Canada and Mexico in dollars:

$5 / $2 = 2.5
 
Therefore, the real exchange rate is 2.5.

Suppose That a Bushel of Wheat Costs $5 in Canada