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Suppose that the real exchange rate between the United States and Kenya is defined in terms of baskets of goods. Which of the following will increase the real exchange rate (that is increase the number of baskets of Kenyan goods a basket of U.S. goods buys?

I. an increase in the number of Kenyan shillings that can be purchased with a dollar
II. an increase in the price of U.S. baskets of goods
III. a decrease in the price in Kenyan shillings of Kenyan goods

A. I and III only.
B. II and III only.
C. I and II only.
D. I only.
E. I, II and III.

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Answer:

E. I, II and III.

Explanation:

Real exchange rate measure the price of foreign goods in comparison to the price of domestic goods. Basically, it can be used to compare the relative value of two baskets of goods in different countries; in this case, it is between Kenya and United States. If it becomes cheaper to buy Kenyan goods than in the U.S , the buyer will have get more for their buck. This means that the value of Kenya shillings has decreased relative to USD. The price of the same basket will be higher in the U.S and lower in Kenya ,making all choices correct.

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