Suppose it takes $1.25$ yen to buy a rupee, and the price level in Japan is $3$ and the price level in India is $1.2$. Calculate the real exchange rate between India and Japan $($the price of Japanese goods in terms of Indian goods$). ($Hint: First find out the nominal exchange rate as a price of yen in rupees$).$
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Price level in foreign country: $($Japan$) P_f = 3$
Price level in home country: $($India$) P = 1.2$
Now, real exchange rate $=\text{e}\frac{\text{P}_{\text{f}}}{\text{P}}$
Price of $1.25$ yen $= 1$ rupee Price of $1$ yen $\frac{1}{1.25}=\frac{100}{125}=\frac{4}{5}\text{rupee}$
Therefore, $\text{e}=\frac{4}{5}$
So, real exchange rate $=\text{e}\frac{\text{P}_{\text{f}}}{\text{P}}$
$=\frac{4}{5}\times\frac{3}{1.2}$
$= 2$ Therefore, the real exchange rate is $2.$
Price level in home country: $($India$) P = 1.2$
Now, real exchange rate $=\text{e}\frac{\text{P}_{\text{f}}}{\text{P}}$
Price of $1.25$ yen $= 1$ rupee Price of $1$ yen $\frac{1}{1.25}=\frac{100}{125}=\frac{4}{5}\text{rupee}$
Therefore, $\text{e}=\frac{4}{5}$
So, real exchange rate $=\text{e}\frac{\text{P}_{\text{f}}}{\text{P}}$
$=\frac{4}{5}\times\frac{3}{1.2}$
$= 2$ Therefore, the real exchange rate is $2.$
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