Consider a two economy world following a fixed exchange rate system. The domestic economy produces commodity X while the foreign economy produces commodity Y with P, = Rs.100 and P = $5. The real exchange rate between the two commodities is ZX for IY. What is the nominal exchange rate between two currencies? Suppose during the following year monetary policies lead to 10% inflation in the domestic economy und 20% in the foreign economy. 2X are still traded for IT. At the end of year what has happened to nominal exchange rate. Which country has had a nominal appreciation? Which has had a nominal depreciation? Which country will benefit / loose from the change value of currency? Draw graphs and explain.
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