Question

In January 2012, one US dollar was worth 50.0 Indian rupees. Suppose that over the next year the value of the Indian rupee decreases to 57.0 Indian rupees to one US dollar. Suppose also that the price level of all goods and services in India, as measured in rupees, falls 21.0%, so that the Indian price index falls from a value of 100 to 79.0. At the same time, suppose that the US price level increases by 6%, to 106.1. By what percentage did the value of the real exchange rate change over this period? Please give your answer to the nearest whole percentage point. 2. What will happen to the following as a result of the changes?a) America's consumption of Indian goods and services will likely _______.b) India's consumption of American goods and services will likely _______.

Answer 1

Answer:

1. By what percentage did the value of the real exchange rate change over this period?

• 53%

2. What will happen to the following as a result of the changes?

• a) America's consumption of Indian goods and services will likely INCREASE. ⇒ (Indian goods are cheaper)
• b) India's consumption of American goods and services will likely DECREASE. ⇒ (American goods are more expensive)

Explanation:

2012 ⇒ 50 rupees per 1 dollar

2013 ⇒ 57 rupees per 1 dollar

price level in India falls by 21%:

price level 2012 = 100

price level 2013 = 79

price level in the US increases by 6%

price level 2012 = 100

price level 2013 = 106

real exchange rate 2012 = [50 x 100 (US price level)] / 100 (India price level) = 50 rupees per dollar

real exchange rate 2013 = [57 x 106 (US price level)] / 79 (India price level) = 76.48 rupees per dollar

the increase in the real exchange rate = (50 - 76.48) / 50 = -53%