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April 27, 2015

Homework Help: Macroeconomics - SOE

Posted by Anonymous on Monday, December 14, 2009 at 11:17am.

Statement:
The lower our real exchange rate is, the less expensive domestic goods are relative to foreign goods, and the greater the demand is for next exports.

I don't get the above statement, please look below to see if there is fault in my reasoning and explain why it is wrong.

From the real exchange rate equation:

E = eP/P* (where E = real exchange, e = norminal exchange, P = foreign price, P* = domestic price)

If E is low, that means the more expensive the domestic goods are compared to foreign goods. This is my observation because E and P* are inversely related according to the equation above. Since E is low, NX is high. This is because e and NX are inversely related and e and E are positively related.

I don't get why a lower real exchange rate leads to a lower price of domestic goods. Please explain. Thanks.

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