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Unformatted text preview: 670 PART ELEVEN THE MACROECONOMICS OF OPEN ECONOMIES gives the answer. As another example, imagine that you are deciding whether to take a seaside vacation in Miami, Florida, or in Cancun, Mexico. You might ask your travel agent the price of a hotel room in Miami (measured in dollars), the price of a hotel room in Cancun (measured in pesos), and the exchange rate be- tween pesos and dollars. If you decide where to vacation by comparing costs, you are basing your decision on the real exchange rate. When studying an economy as a whole, macroeconomists focus on overall prices rather than the prices of individual items. That is, to measure the real ex- change rate, they use price indexes, such as the consumer price index, which mea- sure the price of a basket of goods and services. By using a price index for a U.S. basket ( P ), a price index for a foreign basket ( P* ), and the nominal exchange rate between the U.S. dollar and foreign currencies ( e ), we can compute the overall real exchange rate between the United States and other countries as follows:...
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- Spring '10