Sources and more resources Assume that the dollar–euro exchange rate is $1.42 per euro, In the previous equation, first note that, in the numerator, you multiply the dollar–euro exchange rate with a euro amount. Real Exchange Rate = (Nominal Exchange Rate x Price of the Foreign Basket) / Price of the Domestic Basket. (Technically, the home and foreign country distinction are irrelevant, and real exchange rates can be calculated between any two countries, as shown below. The real exchange rate (RER) compares the relative price of two countries’ consumption baskets. She teaches economics at Harvard and serves as a subject-matter expert for media outlets including Reuters, BBC, and Slate.
When working through the units, it becomes clear that this calculation results in units of foreign good per unit of domestic good.In practice, real exchange rates are usually calculated for all goods and services in an economy rather than for a single good or service. In the US it would cost a dollar and in France it would cost about 1.14 euros. In this example, if the real exchange rate is 1.07 bottles of European wine per bottle of US wine, then the real exchange rate is also 1/1.07 = 0.93 bottles of US wine per bottle of European wine.Mathematically, the real exchange rate is equal to the nominal exchange rate times the domestic price of the item divided by the foreign price of the item. The nominal exchange rate is 7, price of a foreign basket is 6, and price of the domestic basket is 5. For example, you may want to know what one dollar can buy in the Euro-zone countries or what one euro can […]
Second, note that you have the dollar price of the American basket in the denominator. Therefore, follow this concept:RER = (Nominal exchange rate x Price of the foreign basket) / (Price of the domestic basket)Consider a numerical example for the RER. ThoughtCo uses cookies to provide you with a great user experience.
It is the rate at which the Britishers can trade its own goods for those of the USA. Putting all of the pieces together, the bottle of US wine can be exchanged for 1.07 bottles of the European wine, and the real exchange rate is thus 1.07 bottles of European wine per bottle of US wine.The reciprocal relationship holds for real exchange rates in the same way that it holds for nominal exchange rates.
You may be interested in getting more information than the relative price of two currencies, or the nominal exchange rate. In this example, the real exchange rate decreases to 0.95:A decline in the real exchange rate indicates that the dollar price of the Euro-zone’s consumption basket decreases, or the dollar’s purchasing power over the Euro-zone’s consumption basket increases. Let's say the U.S. dollar has trading relationships with the eurozone, Great Britain, and Australia … )The following example illustrates this principle: if a bottle of US wine can be sold for $20, and the nominal exchange rate is 0.8 Euro per US dollar, then the bottle of US wine is worth 20 x 0.8 = 16 Euro.
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real exchange rate formula