What is happening to the Georgian real exchange rate in each of the following situations? Explain....

What is happening to the Georgian real exchange rate in each of the following situations? Explain.

a) Georgian nominal exchange rate is unchanged, but prices rise faster in Georgia than abroad.

b) Georgian nominal exchange rate declines, and prices are unchanged in Georgia and abroad.

c) Georgian nominal exchange rate declines, and prices rise faster abroad than in Georgia.

d) Prices in Georgia decline and purchasing power parity holds.

e) Prices abroad increase and purchasing power parity holds.

Solutions

Expert Solution

a) The real exchange rate increases
Explanation: The real exchange rate will be computed as the nominal exchange rate times the domestic price level divided with the price level in foreign.
Real Exchange Rate = [(Nominal exchange rate) * (Price of the good 1 abroad / Price of good 1 at home)]
The real exchange rate increases because the domestic price will be the multiplying factor in the formula
b) The real exchange rate falls
Explanation: The real exchange rate falls because the nominal exchange value is the multiplying factor that causes a fall in the entire value
c) The real exchange rate falls
Explanation: The dividing factor is increasing and multiplying factor is declining, as a result the real exchange rate falls
d) The real exchange rate remains constant
Explanation: When PPP holds the real exchange rate remains constant

The real exchange rate increases because the domestic price will be the multiplying factor in the formula

Rahul Sunny answered 2 years ago

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