Given the Australian price level P, the foreign country price level P*, and the nominal exchange rate E in foreign currency per Australian dollar, the real exchange rate RER is given by
A)RER = E × (P/P*)
B)RER = (P/P*)/ E
C)RER = E × (P*/P)
D)RER = P × (E/P*)

Question

Quizplus · Accepted Answer

The real exchange rate is the ratio of the price of a set of goods in one country to the price of the same set of goods in another country, adjusted for the exchange rate. In this case, the real exchange rate is given by the ratio of the Australian price level to the foreign country price level, multiplied by the nominal exchange rate. This is because the nominal exchange rate tells us how many units of foreign currency are needed to buy one unit of Australian currency, and the price level tells us how many units of currency are needed to buy a set of goods.

Given the Australian Price Level P, the Foreign Country Price