I’m trying to understand the concept of “real S” through an example… S = 1.6 $/€ My consumer basket is an iPod touch: €289 in France and $299 in US. So PF=$462.4 and PD = 299 Real S = S \* PF / PD = 1.6 \* 462.4 / 299 = 2.47 /€ I would rather expect the following: Real S = S * PD / PF = 1.6 * 299 / 462.4 = 1.03 /€ Using this rate, the consumer basket is properly converted: €289 \* 1.03 /€ = 299... This real S is the exchange rate that Apple is using to convert prices from to €. What is wrong with my first calculation?
Euro = 1.6 US dollars Euro - foreign, dollar - domestic PF = 289 PD = 299 Real Rate of Euro = S*PF/PD = 1.6*289/299 = 1.5465 US dollars
if the CFA book, there are like 3 or 4 of these questions right in a row in the back of the chapter. good practice.
think of it in the simple examples they give… 2*1/2=1 I think the spot is 2 DC/FC and the ratio of consumption basket is 1 FC to 2 DC thus real exchange rate of 1 you are over analyzing this…you are using nominal figures that don’t fit with PPP, there is huge arbitrage based on your example. ALSO, and most importantly you don’t convert the foreign currency