Question : The real exchange rate is calculated by:
Option 1: Dividing the nominal exchange rate by the inflation rate.
Option 2: Multiplying the nominal exchange rate by the inflation rate.
Option 3: Adding the inflation rate to the nominal exchange rate.
Option 4: Subtracting the inflation rate from the nominal exchange rate.
Correct Answer:
Dividing the nominal exchange rate by the inflation rate.
Solution : The correct answer is (a) Dividing the nominal exchange rate by the inflation rate.
The real exchange rate is calculated by adjusting the nominal exchange rate for differences in the inflation rates between two countries. It reflects the relative purchasing power of two currencies and measures the amount of goods and services that can be exchanged between two countries. By dividing the nominal exchange rate by the inflation rate, you are effectively removing the inflationary impact on the exchange rate and obtaining a measure of the real purchasing power of the currencies.
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