Answer to Question #304384 in Macroeconomics for Shriram

Question

1.Define nominal exchange rate and real exchange rate.

2.What are the two main types of exchange-rate systems?

3.What explains the behavior of net exports represented by the J curve?

4.How does real exchange rate affect net exports? Explain and give one example.

Answer 1

1.Nominal exchange rate is the price of one currency in terms of another, expressed as the domestic price of one currency in terms of another. Real exchange rate indicates how much the goods and services in the domestic country can be exchanged for goods and services in a foreign country. It is the nominal exchange rate multiplied by the ratio of prices between the two countries.

2.The two main types of exchange-rate systems are the fixed and the float systems. A fixed exchange rate system is a currency system through which governments attempt to keep their currency value constant against a particular currency or good. A floating exchange rate is whereby the value of the currency is left to freely fluctuate according to the foreign exchange market.

3.The behavior of net exports as represented by the J curve is because prices of exports rise before quantities can adjust, and the nominal trade deficit initially grows after a devaluation. As the quantities adjust, there is an increase in imports as exports remain static, and the trade deficit shrinks into a surplus forming a J shape.

4.When there's high real exchange rate within a country, the relative price of goods at home is higher than the relative price of goods abroad. Thus, when the real exchange rate is high, net exports decrease as imports rise. Alternatively, when the real exchange rate is low, net exports increase as exports rise.