The real exchange rate (R)

Real exchange rate (R): a country's price-level adjusted exchange rate.
The real exchange rate compares the price of domestic products to the price of foreign products, both expressed in a common currency.

    The formula: R = E·Pdom/Pfor
where
   (1) E=the foreign-currency value of domestic currency,
   (2) Pdom=the domestic-currency price of domestic products, and
   (3) Pfor=the foreign-currency price of foreign products.

    Note that E·Pdom tells you the foreign-currency price of domestic products, so R tells you how expensive domestic products are compared to foreign products, expressed in a common currency.
    Real appreciation can occur 3 ways:
   (1) nominal appreciation (+E)
   (2) higher domestic prices (+Pdom)
   (3) lower foreign prices (-Pfor)

Example: suppose the U.S. and Germany trade only beer (prices are per 6-pack):

Row			April	May
1.	E (€ per $)		1.00	1.25
2.	U.S.: Price of Budweiser (Bud)		$3.00	$3.00
3.	Germany: Price of St. Pauli Girl (Spg)		€3.00	€5.00

4.	Option 1: compare prices in €:
		Formula
5.	P of Bud in €:
6.	P of Bud / P of Spg:

7.	Option 2: compare prices in $:
8.	P of Spg in $:	row3/row1
9.	P of Bud / P of Spg:	row2/row8

(1) Did the dollar experience nominal appreciation or depreciation? ____________
(2) Did the dollar experience real appreciation or depreciation? ____________

    Notes:
    (1) It doesn't matter which currency you use to calculate R, as long as you use the same one to compare prices of domestic and foreign products.
    (2) The real exchange rate is the key to a country's international competitiveness:
        Real depreciation (-R) => enhanced international competitiveness of domestic products;
        Real appreciation (+R) => reduced international competitiveness of domestic products.