Suppose it takes 1.25 yen to buy a rupee, and the price level in Japan is 3 and the price level in India is 1.2. Calculate the real exchange rate between India and Japan (the price of Japanese goods in terms of Indian goods). (Hint: First find out the nominal exchange rate as a price of yen in rupees).

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Solution

Price level in foreign country: (Japan) P_f = 3

Price level in home country: (India) P = 1.2

Now, real exchange rate

Price of 1.25 yen = 1 rupee

Price of 1 yen

Therefore,

So, real exchange rate

= 2

Therefore, the real exchange rate is 2.

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Price level in foreign country: (Japan) Pf = 3 Price level in home country: (India) P = 1.2 Now, real exchange rate Price of 1.25 yen = 1 rupee Price of 1 yen Therefore, So, real exchange rate = 2 Therefore, the real exchange rate is 2.

Price level in foreign country: (Japan) P_f = 3

Price level in home country: (India) P = 1.2

Now, real exchange rate

Price of 1.25 yen = 1 rupee

Price of 1 yen

Therefore,

So, real exchange rate

= 2

Therefore, the real exchange rate is 2.