Suppose that last year, the nominal exchange rate between the euro and the British pound was €0.80 per £1.0, one unit of German output cost €4.0, and one unit of British output cost£6.0.
a. What was last year's real exchange rate between the U.K. and Germany, expressed as the cost of British output (i.e. - the quantity of German output that exchanges for 1 unit of British output)? In which country were goods more expensive last year?
b. Suppose that between last year and this year the British pound depreciated by 25% againstthe euro (a 25% decrease in the number of euros required to buy 1 pound). If the price ofgoods in the U.K and Germany are unchanged from last year, what is this year's new realexchange rate? In which country are goods more expensive this year?
c. Now suppose, instead, that between last year and this year, the pound depreciated by 25% against the euro and Germany experienced a 30% increase in its price level (a 30% increasein the number of euros required to purchase one unit of German output). All else equal, what is this year's real exchange rate in that case? In which country are goods more expensive this year?