Suppose the cost of a typical basket of goods is $100 in the United States and 500 yuan in China. If the nominal exchange rate is 10 yuan per dollar, what is the real exchange rate?
A) 1
B) 2
C) 3
D) 4

Question

Quizplus · Accepted Answer

To find the real exchange rate, we need to compare the price of the basket of goods in both countries after taking into account the exchange rate. In this case, we need to convert the cost in yuan to dollars (500 yuan / 10 yuan per dollar = $50). The real exchange rate is then calculated as the ratio of the price of the basket of goods in China to the price of the basket of goods in the United States, adjusted for the exchange rate (500 yuan / $100 = 5). Therefore, the real exchange rate is 5 yuan per dollar or 1/5 = 0.2 dollars per yuan. This can also be expressed as 1 dollar = 5 yuan or 1 yuan = 0.2 dollars. To simplify, we can divide the exchange rate by 2 to get the real exchange rate as 2 yuan per dollar or 1/2 = 0.5 dollars per yuan. Therefore, the best choice is B since it reflects the real exchange rate after adjusting for the exchange rate.

Suppose the Cost of a Typical Basket of Goods Is