Nominal exchange rate e of a countrys X national currency b

Nominal exchange rate (e) of a country\'s X national currency - bolivar - is: 20 bolivars = 1 USD. At 1,000 bolivars in the country X it is possible to purchase as much of goods and services as for 50 USD in the USA. Find the real exchange rate (q) of bolivar against USD. Is bolivar undervalued or overvalued? National currency of a country Z is devaluated by 25%. The coefficient of price elasticity of exports demand (EpX) is estimated as 0.4, the coefficient of price elasticity of imports demand (EpM) is supposed to equal 0.2. Find whether the devaluation will improve the trade balance of the country.

Solution

4. Real Exchange Rate = Nominal exchange Rate * Domestic Price Level/Foreign Price Level

=20 *50/1,000

=1

Real Exhange rate is 1,Hence currency is undervalued.

5. for successful of devaluation the sum total of Export and import price elasticities should be greater than 1 but here sum is less than 1 (0.4+0.2). Hence,it will not improve the balance of trade of country.