What is happening to the U.S. real exchange rate in each of the following situations? Explain. a. The U.S. nominal exchange rate is unchanged, but prices rise faster in the United States than abroad. b. The U.S. nominal exchange rate is unchanged, but prices rise faster abroad than in the United States. c. The U.S. nominal exchange rate declines, and prices are unchanged in the United States and abroad. d. The U.S. nominal exchange rate declines, and prices rise faster abroad than in the United States.

The nominal exchange rate (E) is a measure of the value of one currency in terms of another. Simply put, it's the rate at which you can swap one currency for another. For instance, if 1 US dollar could be exchanged for 50 units of a foreign currency, the nominal exchange rate would be 1:50. However, this rate doesn't take into account the differences in price levels between two countries; that's where the real exchange rate comes into play.
When it comes to analyzing scenario changes, the nominal exchange rate serves as a starting point. If the rate remains the same while price levels diverge, as seen in exercise situations a and b, it indicates that the exchange rate itself isn't shifting, but the relative purchasing power of currencies is changed due to inflation or deflation dynamics. An unchanged nominal exchange rate paired with rising domestic prices (as in scenario a) leads to domestic goods becoming more expensive relative to foreign goods. In international economics, understanding these dynamics is crucial for assessing trade competitiveness, foreign investment attractiveness, and overall economic health.

Price level adjustments are changes in the general price of goods and services within an economy. They are a critical factor in determining the real exchange rate, because they directly affect the purchasing power of a currency. In the context of the exercise, these adjustments help explain the shifts in the real exchange rate when the nominal rate is static.

In scenario a, when prices rise faster in the U.S. than abroad, the increased price level (P) in the U.S. leads to a decrease in the real exchange rate. Effectively, U.S. goods become more expensive, and if the nominal exchange rate does not adjust to this change, the real purchasing power of U.S. currency decreases. Conversely, in scenario b, a faster rise in prices abroad compared to the U.S. means that foreign goods become relatively more expensive, resulting in an increase in the U.S. real exchange rate. Price level adjustments are a day-to-day reality for economies, impacted by factors such as monetary policy, supply and demand dynamics, and economic shocks. They need to be closely monitored for accurate assessments in international trade and finance.

International economics is the study of how countries engage with one another through trade, finance, and policies. It involves analyzing how goods, services, and resources are exchanged across borders and the implications of these exchanges on global and national economies. In our textbook exercise, the concept is illustrated by examining the effects of nominal exchange rate changes and price level adjustments on the real exchange rate—central to understanding international trade competitiveness.

In scenario c, a declining nominal exchange rate, with stable domestic and foreign price levels, would typically bolster a country's trade position by making its exports cheaper on the international market. Similarly, scenario d shows how both a declining nominal exchange rate and faster price rise abroad can work together to significantly enhance a country's competitive edge in international trade. International economics thus provides the framework to interpret such situations, guiding policymakers, businesses, and investors in making informed decisions that hinge on the complex interplay of currencies, prices, and economic activity across nations.