this one stumped me… At the beginning of the period, the exchange rate between Country A and Country B is 3 (quoted as A/B). The ratio of the prices of the consumption basket in Country A to Country B is 2. During the year, Country A has inflation of 10% and Country B has inflation of 0%. At the end of the year, the exchange rate is 3.5. What is the end-of-period real exchange rate? A) 1.59. B) 1.00. C) 1.50.

A?

3.5/2.2 = 1.59090 = A?

A?

We know that real exchange rate is equal to RER = Nominal rate * P/P* where Nominal rate is in terms of A/B P/P* is the difference in basket of goods between to the two countries expressed in B/A goods (notice how A/B and B/A cancel so your real exchange rate isn’t in terms of any currency) At the beginning, nominal rate A/B = 2 P/P* = 1 / 2 (in terms of B/A) RER at the beginning is then 3* 1/2 = 1.5 This is the beginning of period exchange rate which is not what the question asks, cancel out c (I’m just doing all this to show the process) Now, at the end of the year basket of goods in country A increases by 10% due to inflation So P/P* = ( 1 / (2*1.1)) = 0.4545 B / A RER = 3.5 * 0.4545 = 1.59 Answer A?

yeah you guys are right. thanks for the explanations.

jut111 Wrote: ------------------------------------------------------- > this one stumped me… > > At the beginning of the period, the exchange rate > between Country A and Country B is 3 (quoted as > A/B). The ratio of the prices of the consumption > basket in Country A to Country B is 2. During the > year, Country A has inflation of 10% and Country B > has inflation of 0%. At the end of the year, the > exchange rate is 3.5. What is the end-of-period > real exchange rate? > > A) 1.59. > > B) 1.00. > > C) 1.50. 1/(2*1.1)*3.5=1.59