Question:

Three years ago, the U.S. dollar/euro exchange rate was 1.32 USD/EUR. Over the last three years, the price level in the United States has increased by 18%, and the price level in the eurozone has increased by 12%. If the current exchange rate is 1.40 USD/EUR, the real exchange rate over the period has:

A increased, and eurozone goods are now more expensive to U.S. consumers.

Explaination

For the base period, three years ago, the real exchange rate is the same as the nominal exchange rate, 1.32 USD/EUR. The real exchange rate over the period has changed from 1.32 to 1.40 x (112 / 118) = 1.3288. This increase in the real USD/EUR exchange rate indicates that the base currency (EUR) has appreciated in real terms so that eurozone goods are now more expensive in real terms to U.S. consumers.