Suppose that the nominal exchange rate is .80 euro per dollar,that the price of a basket of goods in the U.S.is $500 and the price of a basket of goods in Germany is 400 Euro.Suppose that these values change to .90 euro per dollar,$600,and 600 euro.Then the real exchange rate would
A)appreciate which by itself would make U.S.net exports fall.
B)appreciate which by itself would make U.S.net exports rise.
C)depreciate which by itself would make U.S.net exports fall.
D)depreciate which by itself would make U.S.net exports rise.

Question

Quizplus · Accepted Answer

The real exchange rate is calculated as the nominal exchange rate multiplied by the ratio of the price of the basket of goods in the foreign country to the price of the basket of goods in the domestic country.

Initially, the real exchange rate was 1 Euro = ($500 / 0.80) = 625 Euro, and after the change, it becomes 1 Euro = ($600 / 0.90) = 666.67 Euro. This means that the Euro has weakened relative to the dollar, or in other words, the dollar has appreciated against the Euro.

Since the real exchange rate has depreciated, it means that it will make U.S. net exports rise, as U.S. goods will become cheaper relative to German goods, leading to an increase in demand for U.S. goods. Hence, the correct answer is D.

Suppose That the Nominal Exchange Rate Is