Suppose that the the us/mexico exchange rate is 40 pesos per dollar, the us price level is 102 and the mexican price level is 120. what is the real exchange rate?

Real exhange rate is 47 pesos per dollars.

Explanation:

The real exhange rate has been calculated by using following formulae.

e = er x (P*/P)

The above equation shows that e depends on the er and the price levels in the two countries. Given the value of er, if the mexico price level P* rises, then the e will fall. Since a pesos is worth less, it will buy fewer dollars. However, if the US price level P rises, then the e will go up. This means that the dollar is worth less, a pesos will buy more dollars.

e= 40 * (120/102) = 47

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