Question 8 Chapter 18 Purchasing power parity
Using data from The Economist's Big Mac Index for 2011, the following table shows the local currency
... [Show More] price
of a Big Mac in several countries as well as the actual exchange rate between each country and the United
States. At the time of the data collection, a Big Mac would have cost you $4.07 in the United States and GBP
2.39 in the United Kingdom. The actual exchange rate between the British pound and the U.S. dollar was
$1.63 per pound. Thedollar price of a Big Mac purchased in the United Kingdom was, therefore, computed
as follows:
For the price you paid for a Big Mac in the United States, you could have purchased a Big Mac in the United
Kingdom and had some change left over for french fries!
Complete the final column of the table by computing the dollar price of a Big Mac for the countries where this
amount is not given.
Note: Round your answers to the nearest cent.
Big Mac Index: July 25, 2011
Local Price
(Foreign
Actual Exchange Rate
(Dollars per unit of foreign
Dollar Price
(Dollars)
currency) currency)
The Eurozone 3.44 1.43
Norway 45.00 0.18
United 2.39 1.63 3.90
Kingdom
Poland 8.63 0.36 3.11
China 14.70 0.16 2.35
Source: “Currency Comparison, To Go,” The Economist, last modified July 28, 2011, accessed April 26, 13,
http://www.economist.com/blogs/dailychart/2011/07/big-mac-index.
Points: 1 / 1
4.92
8.10
$1.18 per euro
appreciated
Purchasing power parity (PPP) theory states that exchange rates would need to equalize the prices of goods
in any two countries. For the dollar price of a Big Mac to be the same in both countries, a U.S. citizen would
need to be able to convert $4.07 into exactly GBP 2.39. To find the exchange rate at which hamburger
purchasing power is the same in both countries, divide the price in the United States by the price in the
United Kingdom:
The exchange rate that would have equalized the dollar price of a Big Mac in the United States and the
Eurozone (that is, the PPP exchange rate for Big Macs) is . This change would mean that
the dollar had against the euro.
Points: 1 / 1
Explanation: Close Explanation
For the dollar price of a Big Mac to be the same in the United States and the Eurozone, a U.S. citizen
would need to be able to convert $4.07 into exactly EUR 3.44. To find the exchange rate at which
Explanation: Close Explanation
To find the dollar price of a Big Mac in the Eurozone, multiply the local currency price by the exchange
rate:
Similar calculations can be performed for Norway:
Explanation: Close Explanation
Arbitrage opportunities exist where a good can be bought in one country at a low price and sold in
another at a higher price. Because Big Macs are cheaper in the United States than in the Eurozone,
this would present such an opportunity.
In reality, PPP is not expected to apply perfectly to goods such as hamburgers, given that people don't
buy Big Macs in one country and sell them in another.
If Big Macs were a durable good that could be costlessly transported between countries, which of the
following would present an arbitrage opportunity? Check all that apply.
Exporting Big Macs from Norway to China
Exporting Big Macs from the United Kingdom to Poland
Exporting Big Macs from the United States to the Eurozone
Points: 1 / 1
hamburger purchasing power is the same in both countries, divide the price in the United States by
the price in the Eurozone:
If the exchange rate had fallen from $1.43 to $1.18, the dollar would have appreciated relative to the
euro because it would require fewer dollars to purchase a single euro. At this exchange rate, the dollar
price of a Big Mac in the Eurozone would have been $4.07 (equal to the dollar price of a Big Mac in the
United States); therefore this is the PPP rate. [Show Less]