 Apply Relative Price to Exchange Rates - dummies

An exchange rate is a relative price because it represents the price of one currency in terms of another currency. Assume that the dollar is the domestic currency and the euro is the foreign currency. The exchange rate between these two currencies implies how many dollars, the domestic currency, are necessary to buy one euro.

However, because an exchange rate is a relative price, you can also define it as the number of euros necessary to buy one unit of the domestic currency (the dollar).

If you define the exchange rate as the amount of domestic currency necessary to buy one euro, this definition implies the price of the euro in dollars. If you define the exchange rate as the number of euros necessary to buy one dollar, this definition indicates the price of the dollar in euros.

Section C4 of the Wall Street Journal (WSJ) of September 10, 2012, listed the euro–dollar exchange rate as €0.7048. This rate means that you need €0.7048 to buy one dollar. This particular exchange rate implies the price of dollars in euros.

Although the WSJ doesn’t list the dollar–euro exchange rate or the price of euros in dollars, you can easily calculate it. Inverting the current exchange rate yields the dollar–euro exchange rate. If then Therefore, the dollar–euro exchange rate implies that you need \$1.42 to buy one euro, which indicates the price of a euro in dollars.