Answer:
3.333% which is approximately 3%.
Explanation:
Real Exchange rate is the price of foreign goods compared to the price of domestic goods. This can be calculated using the following formula:
R = NER × (DPL ÷ FPL) ............................................... (1)
Where:
R = Real Exchange Rate
NER = Norminal Exchange Rate
DPL = Domestic Price Level
FPL = Foreign Price Level
When there is a change in the real exchange rate, equation (1) will expressed is follows:
ΔR = ΔNER × (ΔDPL ÷ ΔFPL) ............................................... (2)
Where:
ΔR = Change in Real Exchange Rate
ΔNER = Change in Norminal Exchange Rate = 5%
ΔDPL = Change in Domestic Price Level = Domestic Inflation = 2%
ΔFPL = Change in Foreign Price Level = Foreign Inflation = 3%
If we substitute all these values into equation (2), we can solve for ΔR as follows:
ΔR = 5% × (2% ÷ 3%)
= 5% × 0.6667
ΔR = 3.333%
Therefore, change in the real exchange rate is 3.333% which is approximately 3%.
