If the nominal exchange rate e is foreign currency per dollar, the domestic price is P, and the foreign price is P*, which of the following is the definition of the real exchange rate?
A)e(P*/P)
B)e(P/P*)
C)e + P/P
D)e - P/P*

Question

Quizplus · Accepted Answer

The real exchange rate is defined as the nominal exchange rate adjusted for the relative price levels between the domestic and foreign economies. Therefore, the correct formula for the real exchange rate is e(P/P*). Option B matches this formula, and is therefore the correct answer. Option A has the right adjustment for relative prices but has reversed the domestic and foreign prices in the formula. Option C and D do not correspond to the correct formula for the real exchange rate.

If the Nominal Exchange Rate E Is Foreign Currency Per