In open economy macroeconomics, the real exchange rate is defined as the relative price of foreign goods in terms of domestic goods. Which type of exchange rate does this describe?

Introduction / Context:
This question tests your understanding of a key concept in international economics: the distinction between nominal and real exchange rates. While the nominal exchange rate tells you how many units of domestic currency you need to buy one unit of foreign currency, the real exchange rate adjusts for price levels and shows the relative price of foreign goods measured in terms of domestic goods. Grasping this concept is essential for analysing competitiveness, trade flows, and purchasing power parity.

Given Data / Assumptions:

• The definition given is the relative price of foreign goods in terms of domestic goods.
• The options are artificial, nominal, fixed, and real exchange rate.
• We assume standard definitions from macroeconomics for these exchange rate terms.
• We are not asked to compute a numerical value, only to identify the correct label.

Concept / Approach:
The real exchange rate compares the price of a representative basket of foreign goods to the price of a similar basket of domestic goods, after converting foreign prices into domestic currency using the nominal exchange rate. It therefore answers the question: how many units of domestic goods are needed to buy one unit of foreign goods. In contrast, the nominal exchange rate expresses the price of one currency in terms of another currency without adjusting for price levels. Fixed versus flexible refers to how the nominal exchange rate is determined, not to this relative price concept. The term artificial is not a standard technical term in this context.

Step-by-Step Solution:
Step 1: Focus on the phrase relative price of foreign goods in terms of domestic goods.Step 2: Recall that the real exchange rate measures foreign prices relative to domestic prices, adjusted by the nominal exchange rate.Step 3: Nominal exchange rate only tells you the price of one currency in terms of another and does not directly relate goods prices.Step 4: Fixed exchange rate describes a regime where the nominal rate is pegged by the government or central bank, not a separate type of rate that measures relative goods prices.Step 5: Artificial exchange rate is not a standard textbook category.Step 6: Therefore, the definition clearly matches the real exchange rate.

Verification / Alternative check:
A common formula for the real exchange rate is: real exchange rate = nominal exchange rate * (foreign price level / domestic price level). When this value is high, foreign goods are relatively expensive in terms of domestic goods, and when it is low, foreign goods are relatively cheap. This is exactly what the phrase relative price of foreign goods in terms of domestic goods means in macroeconomic analysis. The nominal exchange rate alone cannot capture this real purchasing power comparison, confirming that the correct answer is real exchange rate.

Why Other Options Are Wrong:
Artificial: This is not a technical term used to classify exchange rates in standard macroeconomic theory.

Nominal: The nominal rate is defined as the price of one currency in terms of another currency and does not adjust for differences in price levels.

Fixed: This describes a policy regime where the nominal rate is pegged, and it can apply to both nominal and real concepts, but it is not the definition given in the question.

Common Pitfalls:
Students often confuse nominal and real concepts in macroeconomics because both involve the term exchange rate. A useful memory aid is to remember that whenever you see a reference to the relative price of goods baskets or purchasing power across countries, the word real is usually involved. Nominal variables are in money terms, while real variables are adjusted for prices and reflect true purchasing power or relative values of goods.

Final Answer:
The relative price of foreign goods in terms of domestic goods is called the real exchange rate.