QUESTION 2. Long Run Exchange Rate Determination and PPP a) Write down the expression for a country's real exchange rate in terms of the nominal exchange rate and aggregate price levels, defining your notation carefully. What does a country's real exchange rate measure and what are its units (of measurement)? b) What does absolute purchasing power parity state that the value of a country's real exchange rate should be? Under what conditions (list them and be specific) would you expect purchasing power parity to be a valid description of a country's real exchange rate and why? c) Now derive an equivalent expression for a country's real exchange rate, in terms of the real exchange rate of traded goods and the relative price of traded to all goods (roughly, non-traded to traded goods). Define your notation carefully. What does each of these two components of the real exchange rate reflect? Empirically, which is more important for real exchange rate movements? Explain your answer. d) Suppose there is a decrease in the foreign country's demand for foreign non-traded goods relative to the foreign country's traded goods. How would you expect this to affect the home country's real exchange rate and why? e) Suppose there is an increase in the home country's traded goods sector productivity relative to the non-traded goods sector's productivity. How do you think this would affect its real exchange rate in the long run