Section 191 The nominal exchange rate between Eurasian and O

(Section 19.1) The nominal exchange rate between Eurasian and Oceanian dollars is 3:1. The average shopping trip costs E$400 in Eurasia and O$75 in Oceania. Which country is cheapest? What is the real exchange rate?

Solution

Nominal exchange rate between Eurasian and Oceanian dollars = 3:1, which means 3 Eurasian dollar will buy one Oceanian dollar
Now a trip cost in Eurasia = E$400
A trip cost in Oceanian = O$75
Now if we convert Oceanian dollar to Eurasia = 75*3 = 225
Which means the trip in Oceanian is cheaper than Eurasisa
The real exchange rate is the tells how much the goods and services in one country can be exchanged for the goods in other country
In Eurasisa, Real exchange rate = (1/3)*(75/400) = 0.0625
In Oceania, Real exchange rate = 3*(400/75) = 16