# Macroeconomics - SOE

posted by .

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.

• Macroeconomics - SOE -

I think of the exchange rate as the number of a foreign currency units per dollar. e.g., euros/dollars. From this perspective, the statement makes perfect sense.

• Macroeconomics - SOE -

Let me elaborate with an example. Say something costs 2 euros and the euros to dollars ratio is 1. So, I need 2 dollars to purchase. (I take my 2 dollars to the exchange, and get 2 euros). Now let the euros/dollars exchange ratio drop to 0.5 NOW, I need to spend 4 dollars to get that same item. (I take 4 dollars to the exchange to get 2 euros). Conversely some guy in France now only needs to give up 1 euro to get 2 dollars.)

Hummmm, exchange rate went down, price of foreign good went up (domestic goods became relatively less expensive). To foreigners, the price of american goods just went down, so demand american exports just went up.

Which is exactly what your statement stays.

• Macroeconomics - SOE -

Consider an economy with a constant nominal money
supply, a constant level of real output Y = 100, and a
constant real interest rate r = 0.10. Suppose that the
income elasticity of money demand is 0.5 and the interest
elasticity of money demand is --0.1.
a. By what percentage does the equilibrium price level
differ from its initial value if output increases to Y =
106 (and r remains at 0.1O)? (Hint: Use Eq. 7.11.)
h. By what percentage does the equilibrium price level
differ from its initial value if the real interest increases
to r = 0.11 (and Y remains at 100)?
c. Suppose that the real interest rate increases to r =
0.11. What would real output have to be for the equilibrium
price level to remain at its initial value?

## Similar Questions

1. ### economics

China is one of the few countries in the world to have a fixed exchange rate. In the past, it has experienced a huge increas in exports of goods. Use a "FOREX" diagram to show the effect of the increase in exports. In your answer you …
2. ### economics

China is one of the few countries in the world to have a fixed exchange rate. In the past, it has experienced a huge increas in exports of goods. Use a "FOREX" diagram to show the effect of the increase in exports. In your answer you …
3. ### MacroEconomics

I have the first 4 parts but fall short on the last 2 answers: For each of the following situations, indicate the direction of the shift in the supply curve or the demand curve for dollars, the factor causing the change, and the resulting …
4. ### econ 181

1. The three reasons for the downward slope of the aggregated demand curve are measured in effect. They are: Real Balances-this is caused by a change in the price levels. Next are Interest Rates-here high price levels increases the …
5. ### Econ

Need help on this question, I tried the ones i know. a The consumption function is C = 1.5 + 0.75(Y-T). What is the marginal propensity to consume, MPC?
6. ### Macroeconomics - NX & Tax

In a small open economy, if the government adopts a policy that lowers imports, then that policy raises the real exchange rate and does not change net exports. I don't get the above statement. From my understanding, lower imports means …
7. ### Macroeconomics - Investment Tax Credit

Assume that some large foreign countries decide to subsidize investment by instituting an investment tax credit. Then the home country's real exchange rate will fall and its net exports will rise. I completely don't understand the …
8. ### Anthropology

Redistribution involves: (Points : 1) the exchange of goods between people already associated with each other. the systematic movement of wealth toward an administrative center and its reallocation by authorities. the exchange of goods …
9. ### Economics

Compensation of employees \$194.2 US exports of goods and services 17.8 Consumption of fixed capital (depreciation) 11.8 Government purchases 59.4 Taxes on production and imports 14.4 Gross private domestic investment 63.9 Transfer …
10. ### Social Studies

Why were Northern states in favor of Hamilton's protective traffic?

More Similar Questions