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Q. Determine the Exchange rate?
Exchange rate is determined by the ratio of domestic price level to the foreign price level. If, for instance domestic prices increase by 10% whereas foreign prices are constant, domestic currency will depreciate by 10% against foreign currency.
With this assumption, imports and exports may be assumed to be independent of the domestic price level. If domestic prices increase by 10% whereas the currency loose 10%, price of domestically produced goods abroad would be unchanged.
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