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

Question

Quizplus · Accepted Answer

The real exchange rate (RER) is calculated as RER = E × (P/P*), where E is the nominal exchange rate (expressed in units of foreign currency per U.S. dollar), P is the domestic price level, and P* is the foreign price level. This formula adjusts the nominal exchange rate by the price levels in the two countries, providing a measure of the relative purchasing power of the two currencies.