Question

The nominal exchange rate is .80 euros per dollar and the real exchange rate is 4/3. Which of the following prices for a particular good are consistent with these exchange rates
A. $4 in the U.S. and 3 euros in Italy

B. $4 in the U.S. and 3.75 euros in Italy

C. $5 in the U.S. and 3 euros in Italy

D. $6 in the U.S. and 2.5 euros in Italy

Answer 1

Answer:

option (C) $5 in the U.S. and 3 euros in Italy

Explanation:

Data provided in the question:

Nominal exchange rate, E = 0.80 euros per dollar

Real exchange rate = $\frac{4}{3}$

Now,

Real exchange rate = [ Price of good in US ] ÷ [ Price of Good in Italy ]

= $\frac{EPU}{PI}$

Here,

PU = Price of US in dollars

PI = Price of Italy in Euros

Thus,

Real exchange in rate

$\frac{4}{3}$ = $\frac{0.8PU}{PI}$

or

$\frac{PU}{PI}$ = $\frac{5}{3}$

hence,

we get

Ratio of Price of a good in US to Price of a Good in Italy = $\frac{5}{3}$

or

we can say $5 in the U.S. and 3 euros in Italy

option (C) $5 in the U.S. and 3 euros in Italy