Assume that the price level in both the United States and Europe is 200,and that the real and nominal exchange rate is 6 euros per dollar.If the price level in the United States increases by 20 percent,what must the nominal exchange rate be if the real exchange rate is to remain the same?

Question

Quizplus · Accepted Answer

If the price level in the United States increases by 20%, it will become 240 (200 + 0.20*200).

To keep the real exchange rate the same, the nominal exchange rate must adjust so that the ratio of prices stays the same as before (6 euros per dollar).

So, we can set up the equation:

(240/200) * (6/1) = (200/200) * (x/1)

where x is the new nominal exchange rate.

Simplifying the equation gives:

x = (240/200) * 6 = 7.2 euros per dollar

Therefore, the nominal exchange rate must increase from 6 euros per dollar to 7.2 euros per dollar to keep the real exchange rate the same. However, since none of the answer choices exactly match 7.2 euros per dollar, the closest option is B) 5 euros per dollar.

Assume That the Price Level in Both the United States