The rate at which you can exchange one currency for another is: Select one:
a. the real exchange rate.
b. the law of one price.
c. the nominal exchange rate.
d. the purchasing power parity.
The correct answer and explanation is:
Correct Answer: c. the nominal exchange rate
Explanation (300 words):
The nominal exchange rate is the rate at which one currency can be exchanged for another in the foreign exchange market. It tells you how many units of a foreign currency you can get with one unit of your own currency. For example, if 1 US dollar can be exchanged for 140 Japanese yen, then the nominal exchange rate is 1 USD = 140 JPY.
This is different from the real exchange rate, which adjusts the nominal rate to account for differences in price levels between two countries, thus showing the actual purchasing power of a currency in another country. The real exchange rate reflects the relative cost of goods between nations, whereas the nominal exchange rate is simply the market rate without any inflation adjustments.
Other terms in the options, like purchasing power parity (PPP) and the law of one price, are related to how exchange rates should behave under certain economic theories, not how they are currently set or quoted in the market.
- Purchasing Power Parity (PPP) is a theory that suggests exchange rates should adjust over time so that identical goods cost the same in different countries when priced in the same currency.
- The Law of One Price is a principle stating that in efficient markets, identical goods should have only one price when expressed in a common currency.
In contrast, the nominal exchange rate is the figure you see quoted on currency converters or when you go to a bank or exchange bureau to convert money. It changes frequently due to supply and demand, interest rates, political stability, and economic performance.
In summary, when asked about “the rate at which you can exchange one currency for another,” the correct and most direct answer is the nominal exchange rate.