Question

Ignore the previous questions. One can exchange the currencies of Aldaria and Borduria at the rate 10 aldas/1 bordo. The price level in Aldaria is 50, while in Borduria the price level is 80. Suppose the price level in Aldaria increases by 10%, while in Borduria the price level increases by 20%. Which of the following statements is correct? O A. The bordo has depreciated in real terms. OB. The alda has appreciated in real terms. OC. The alda has depreciated in nominal terms. OD. The bordo has appreciated in real terms. O E. None of the choices is correct.

Answer 1

The correct answer is (b) The alda has appreciated in real terms.

Increase in Price level of Alda = 50 + 10% = 55

Increase in Price level of Bordo = 80 + 20% = 96

Current exchange rate is 10 aldas / 1 bordo

After increase in price level, change in exchange rate will be = 10 * [( 1 + 0.55) / (1 + 0.96)]

= 10 * (1.55 / 1.96)

= 10 * 0.79

= 7.9 aldas / 1 bordo

From the above exchange rate we can understand that for 1 bordo we will need 7.9 aldas whereas earlier we needed 10 aldas for 1 bordo. This means that alda has appreciated and become more valuable.