Question

Three years ago, the U.S. dollar/euro exchange was 1.32 USD/EUR. Over the last three years, the price level in the United States has increased by 18%, and the price level in the Eurozone has increased by 12%. If the current exchange rate is 1.40 USD/EUR, the real rate over the period has: A. increased, and Eurozone goods are now more expensive to U.S. customers. B. decrease, and Eurozone goods are now more expensive to U.S. customers. C. increases, and U.S. goods are now more expensive to Eurozone customers.

Answer 1

Answer:

A. increased, and Eurozone goods are now more expensive to U.S. customers

Explanation:

The exchange rate represents a link between domestic prices and foreign prices, so Three years ago, Price in the Eurozone was:

P1 (US)= 1.32 USD / EUR * P1 (Eurozone)

Now, after three years of inflation, the new prices are

P2 (US)= 1.18* P1 (US)

P2 (EUROZONE) = 1.12 *P1 (EUROZONE)

So, if we replace in the equation =

P2 (US)/1.18 = 1.32 * P2 ( EUROZONE)/1.12

P2 (US) = (1.32 * 1.18)/1.12 *P2 (EUROZONE)

P2 (US) = 1.39 P2 (EUROZONE)

As we can see, the teorical exchange rate should be 1.39 but we have a REAL exchange rate of 1.4, which is greater, the prices are now more expensive to US customers