Macroeconomics - SOE

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.

  1. 👍 0
  2. 👎 0
  3. 👁 360
  1. 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.

    1. 👍 0
    2. 👎 0
  2. 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.

    1. 👍 0
    2. 👎 0
  3. 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?

    1. 👍 0
    2. 👎 0

Respond to this Question

First Name

Your Response

Similar Questions

  1. Statistics

    The mean cost of domestic airfares in the United States rose to an all-time high of $385 per ticket. Airfares were based on the total ticket value, which consisted of the price charged by the airlines plus any additional taxes and

    asked by Sam on June 11, 2014
  2. finance

    Assume that the export price of a Nissan XTerra from Osaka, Japan is ¥3,750,000. The exchange rate is ¥121.84/$. The forecast rate of inflation in the United States is 2.8% per year and is 0.6% in Japan. a. What is the export

    asked by Sara on May 5, 2011
  3. Economics

    Country A and B are small open economies. Their economies depend on each other heavily for trade, but their respective governments don't always work together when setting economic policy. Assume (for simplicity) that these

    asked by Casey on June 9, 2020
  4. economics

    Suppose that people consume only three goods, as shown in this table: (5 Marks) Tennis Balls Tennis Racquets Gatorade 1998 price $2 $40 $1 1998 quantity 100 10 200 1999 price $2 $60 $2 1999 quantity 100 10 200 What is the

    asked by shelby on September 25, 2006
  5. 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

    asked by Anonymous on June 25, 2013
  1. Economics

    The real value of the U.S. dollar is determined by the U.S. government value of goods and services it buys*** U.S. investors in the foreign market foreign investors in the foreign exchange market supply and demand in the open

    asked by TM on December 1, 2018
  2. differentiability

    If g is a differentiable function such that g(x) is less than 0 for all real numbers x and if f prime of x equals (x2-4)*g(x), which of the following is true? A. f has a relative maximum at x=-2 and a relative minimum at x=2, B. f

    asked by matthew on December 31, 2010
  3. Calculus

    True or False: Consider the following statement: A differentiable function must have a relative minimum between any two relative maxima. Think about the First Derivative Test and decide if the statement is true or false. I want to

    asked by Mishaka on December 10, 2011
  4. 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? What is the marginal propensity to save, MPS? ans: MPC=0.75 and

    asked by Bo on July 21, 2008
  5. Financial Management

    1. The financial markets allocate capital to corporations by a)reflecting expectations of the market participants in the prices of the corporation's securities. b)requiring higher returns from companies with lower risk than their

    asked by Laura on October 7, 2008
  6. history SUE HELP MEEEE

    In The Wealth of Nations, Adam Smith mentions that very good grapes could be grown in Scotland. However, growing high quality grapes in Scotland would be about 30 times as expensive as purchasing grapes from foreign countries.

    asked by SUUUE and REED HELP ME on February 28, 2016

You can view more similar questions or ask a new question.