If the nominal dollar price of the euro decreases by 10% (from $1.00 to $.90) and the ratio of the price level in Europe to the price level in the U.S. increases by 20%, the real dollar price of the euro will
A) increase.
B) decrease.
C) stay the same.
D) increase and then decrease.

Question

Quizplus · Accepted Answer

The real dollar price of the euro is affected by both the nominal exchange rate and the relative price levels (inflation rates) in the two economies. A 10% decrease in the nominal dollar price of the euro makes the euro cheaper in nominal terms. However, if the ratio of the price level in Europe to the price level in the U.S. increases by 20%, it means that prices in Europe have increased relative to prices in the U.S., making the euro effectively more expensive in real terms. Therefore, the real dollar price of the euro increases.

If the Nominal Dollar Price of the Euro Decreases by 10