The exchange rate between the US dollar and the British poun

The exchange rate between the US dollar and the British pound is 0.20 (0.20 pound per dollar). In England, the price level is 1.0 and the interest rate is 20%. In the US, the price level is 0.5 and the interest rate is 8%. The inflation rate in both countries is zero.

One unit of a \"US good\" will buy

Select one:

a. 1 units of UK goods.

b. 0.1 units of UK goods.

c. 10 units of UK goods.

d. 5 units of UK goods.

e. 2 units of UK goods.

Solution

e = er x (P*/P)

where e is the exchange rate

er is real exchange rate

p* is foreign prices

p is domestic prices

real exchange rate =0.2*0.5 =0.1

this means that one US good is worth b.) 0.1 units of UK goods.