Suppose the nominal exchange rate between the Japanese yen and the SA rand is 100 yen per rand.Further, suppose that a kilogram of rice costs R2 in SA and 250 yen in Japan.What is the real exchange rate between Japan and SA?
A)0.5 kilograms of Japanese rice per kilogram of SA rice.
B)0.8 kilograms of Japanese rice per kilogram of SA rice.
C)1.25 kilograms of Japanese rice per kilogram of SA rice.
D)2.5 kilograms of Japanese rice per kilogram of SA rice.
E)None of these answers.

Question

Quizplus · Accepted Answer

The real exchange rate measures the price ratio of identical goods between two countries. In this case, we can use the price of rice in Japan and SA to calculate the real exchange rate.

Using the price of rice in SA, we can calculate the implied exchange rate: 
1 kg of rice in SA = R2 
1 kg of rice in Japan = 250 yen
Therefore, the implied exchange rate is: 
1 rand = 125 yen (because 2 rand = 250 yen)

Comparing this implied exchange rate to the nominal exchange rate (100 yen/rand), we can see that the rand is overvalued relative to the yen. To find the real exchange rate, we divide the nominal exchange rate by the ratio of prices: 
Real exchange rate = nominal exchange rate / (price in Japan / price in SA) 
Real exchange rate = 100 yen/rand / (250 yen / R2) 
Real exchange rate = 100 yen/rand / 125 yen/rand 
Real exchange rate = 0.8

Therefore, the real exchange rate is 0.8 kilograms of Japanese rice per kilogram of SA rice.

Suppose the Nominal Exchange Rate Between the Japanese Yen and the SA