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In January 2012, one US dollar was worth 50.0 Indian rupees. Suppose that over the next year the value of the Indian rupee decreases to 63.0 Indian rupees to one US dollar. Suppose also that the price level of all goods and services in India, as measured in rupees, falls by 15.0 % , so that the Indian price index falls from a value of 100 to 85.0 . At the same time, suppose that the American price level increases by 6 % , to 106.

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Edufirst

Answer:

  • The value of the real exchange rate decreased 1%

Explanation:

Question: By what percent did the value of the real exchange rate change over this period? To the nearest whole percentage point.

Solution

January 2012 (First day of the month):

  • USD 1 = IRP 50.0                 (use the symbol IRP for Indian rupees.)

December 2012 (last day of the month):

  • USD 1 = IRP 63.0
  • Deflation rate in India: 15.0%

                                    ⇒ IRP 63.0 × 0.85 = IRP 53.55

       This means that, at the end of the years, IRP 53.55 purchases the same that IRP 63.3 at the start of the year.

  • Inflation rate in USA:  6%

                                 ⇒ USD 1 × 1.06 = USD 1.06

        This means that at the end of the year purchased the same as USD 1 at the start of the year.

Real exchange rate change:

  • Find the ratio of the two values at the end of the year.

                            USD 1.06 = IRP 53.55

                            USD 1 = IRP 53.55/1.06 = IRP 50.52

                            USD 1 = IRP 50.52

  • The change in the rate is is:

                            [50.52 - 50.00] / [50.00] × 100 = 1.04% = 1%

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