Which exchange rate measures the purchasing power of each currency for domestic and foreign goods?

The real exchange rate is the correct choice because it reflects the purchasing power of a currency in terms of the amount of goods and services it can buy, both domestically and abroad. It adjusts the nominal exchange rate for differences in price levels between countries, thereby providing a more accurate picture of the currency's value.

When we consider what the real exchange rate measures, it takes into account the relative prices of goods in two different economies, allowing for comparisons of purchasing power. This is particularly important for understanding how much one currency can actually buy in a foreign market compared to its domestic purchasing power, which is crucial for businesses and consumers making international transactions.

The nominal exchange rate, on the other hand, simply indicates the relative price of one currency in terms of another without adjustments for inflation or price levels. This means it does not provide insights into the true purchasing power of the currencies involved. The adjustable and relative exchange rates are not standard terms used in economics to describe these specific purchasing power comparisons. Thus, understanding the role of the real exchange rate helps clarify how currency values interact in the context of international trade and economic performance.