Question

In: Economics

Let E denote units of domestic currency per unit of foreign currency; P, P* the domestic...

Let E denote units of domestic currency per unit of foreign currency; P, P* the domestic and foreign price index, respectively.

Year E P P* EP*/P
1 1.0 100 100 1.0
2 1.1 110 - 1.0
3 1.1 - 110 1.1
4 1.1 110 121 -
5 - 110 121 1.155

Fill in the missing elements of the table above and answer the following questions:

(a) Between which years did the domestic nominal exchange rate change?

(b) Bewteen which years did the domestic real exchange rate change?

(c) Did the domestic nominal exchange rate depreciate or appreciate bwtween year 1 and year 5?

(d) Did the domestic real exchange rate depreciate or appreciate between year 1 and yaer 5?

Solutions

Expert Solution

Complete the table as follows:

Year E P P* EP*/P
1 1.0 100 100 1.0
2 1.1 110 100 1.0
3 1.1 110 110 1.1
4 1.1 110 121 1.21
5 1.05 110 121 1.155

Formula used:

Real Exchange Rate = EP*/P

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(a) Between which years did the domestic nominal exchange rate change?

The domestic nominal exchange rate changed in Year 2, remained constant between Years 3 and 4, and again changed in Year 5.

This is shown in Column 1 of the table.

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(b) Between which years did the domestic real exchange rate change?

The domestic real exchange rate changed between Years 3 and 5.

This is shown in Column 5 of the table.

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(c) Did the domestic nominal exchange rate depreciate or appreciate between year 1 and year 5?

The domestic nominal exchange rate depreciated from Year 1 to Year 2. From Years 2 to 4, it remained constant. In Year 5, it appreciated slightly.

Here, appreciation means that now 1 unit of foreign currency is cheaper.

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(d) Did the domestic real exchange rate depreciate or appreciate between year 1 and year 5?

The real exchange rate remained constant from Years 1 to 2. In Years 3 and 4, it depreciated. In Year 5, it appreciated slightly.

Here, appreciation means that now 1 unit of foreign goods are cheaper.


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