Definition – What is the real exchange rate?
The real exchange rate is an indication of what an equivalent good would cost in your economy.
A regular exchange rate demonstrates how much two currencies can be traded for.
The real exchange rate demonstrates how much an item sold in foreign currency would cost in local currency.
Formula – How to calculate the real exchange rate
Real Exchange Rate = (Nominal Exchange Rate x Price of the Foreign Basket) / Price of the Domestic Basket
The nominal exchange rate is 7, price of a foreign basket is 6, and price of the domestic basket is 5.
Real Exchange Rate = (7 x 6) / 5 = 42 / 5 = 8.4
Therefore, the real exchange rate is 8.4.