Answer: Option A
Answer: (a)
Suppose Nominal Exchange Rate is $1 = Rs.60
Burger Price - India : Rs. 30, US : $1 Whether India will export burgers to US or not depends on three parameters/prices
Price of Burger in US (directly proportional, i.e. if it increases, exports to US will increase)
Price of Burger in India (indirectly proportional, i.e. if it increases exports to the US $ will decrease)
Nominal Exchange Rate (directly proportional, i.e. if it increases exports to US $ will increase)
And all the three parameters are captured in Real Exchange Rate
Real Exchange Rate = $\text"Price in US X Nominal Exchange Rate"/\text"Price in India"$
= ${1 X 60}/30$ = 2
Till Real Exchange Rate > 1, India will continue to export its burgers to the US. If Real Exchange Rate becomes equal to 1, then export & import will stop. If Real Exchange Rate is < 1, then the US will start exporting its burgers to India. So Real Exchange Rate determines export competitiveness between two countries.
But if India wants to measure its export competitiveness with all its trading partners then it calculates the Real Effective Exchange Rate which is a weighted average (weights being the shares in foreign trade with respective countries) of the Real Exchange Rates of its different trading partners.
If the real effective exchange rate appreciates that means it moves from 2 to 1 (in the example above) which means the export competitiveness of Indian products will start reducing.