If we let P = the domestic price of a basket of goods and Pf the foreign price of the same basket of goods, and Ɛ= the nominal exchange rate of U.S. $/foreign currency the real exchange rate is best expressed as:

Question

Quizplus · Accepted Answer

The real exchange rate is the ratio of the domestic price of a basket of goods to the foreign price of the same basket of goods, 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 domestic currency, and the real exchange rate tells us how many units of foreign goods can be bought with one unit of domestic goods.

If We Let P = the Domestic Price of a Basket