7. Computing real exchange rates Consider a basket of consumer goods that costs

Question

7. Computing real exchange rates

Consider a basket of consumer goods that costs $90 in the United States. The same basket of goods costs CNY 105 in China.

Holding constant the cost of the basket in each country, compute the real exchange rates that would result from the two nominal exchange rates in the following table.

Cost of Basket in U.S. (Dollars) 90 90 Cost of Basket in China Nominal Exchange Rate (Yuan per dollar) 7.00 10.50 Real Exchange Rate (Baskets of Chinese goods per basket of U.S. goods) 105 105

Explanation / Answer

Cost of basket in US at 7 nominal rate = Cost of basket in US dollar × Yuan per dollar

                                                              = 90 × 7

                                                              = 630

Real exchange rate = (Cost in US) / (Cost in C) = 630 / 105 = 6 (Answer)

Cost of basket in C at 10.50 nominal rate = Cost of basket in US dollar × Yuan per dollar

                                                                   = 90 × 10.50

                                                                   = 945

Real exchange rate = (Cost in US) / (Cost in C) = 945 / 105 = 9 (Answer)

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