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If the price level in Japan is 3.0, the price level in Australia is 6.0, and it costs 50 Yen to buy one Australian dollar, then the real exchange rate between Australia and Japan (the price of domestic goods in terms of Japanese goods) is

Question

If the price level in Japan is 3.0, the price level in Australia is 6.0, and it costs 50 Yen to buy one Australian dollar, then the real exchange rate between Australia and Japan (the price of domestic goods in terms of Japanese goods) is

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Solution

To find the real exchange rate between Australia and Japan, we need to use the formula for the real exchange rate:

Real Exchange Rate=(E×P∗P) \text{Real Exchange Rate} = \left( \frac{E \times P^*}{P} \right)

where:

  • E E is the nominal exchange rate (the price of one unit of foreign currency in terms of domestic currency),
  • P∗ P^* is the foreign price level,
  • P P is the domestic price level.

In this case:

  • E=50 E = 50 Yen per Australian dollar,
  • P∗=6.0 P^* = 6.0 (price level in Australia),
  • P=3.0 P = 3.0 (price level in Japan).

Now, substitute these values into the formula:

Real Exchange Rate=(50×6.03.0) \text{Real Exchange Rate} = \left( \frac{50 \times 6.0}{3.0} \right)

Calculate the numerator:

50×6.0=300 50 \times 6.0 = 300

Now, divide by the domestic price level:

3003.0=100 \frac{300}{3.0} = 100

Therefore, the real exchange rate between Australia and Japan is 100.

This problem has been solved

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