Country Big Mac price in local currency Market Exchange Rate US $ 3 $1= $1 UK 2
ID: 1212612 • Letter: C
Question
Country Big Mac price in local currency Market Exchange Rate
US $ 3 $1= $1
UK 2 $1= 0.6
Japan 260 $1= 120
Euro Area 2.8 $1=0.83
Calculate for each of the above (a) the implied PPP and (b) what that rate says about
the market value of each respective currency.
Explanation / Answer
The price of a Big Mac in the U.S.A. is $3. The price of a Big Mac in the Euro Zone is € 2.28 (= $4.0794 in the U.S. Dollar. Varies by region.) The implied PPP Is = € 2.28/$3 = 0.76 Actual exchange rate was $1 = € 0.83 {(0.76 - € 0.83)/€ 0.83}X 100 = -8.4% undervalued against the U.S. Dollar Similarly, implied PPP in UK = $3/2 = 1.5 Exchange rate = 0.6 (1.5-0.6)/0.6 * 100 = 150% overvalued against USD Implied PPP in Japan, 3/260 = 0.01154 Exchange rate = 120 (0.01154-120)/120 *100 = -99.9% undervalued against USD Thus the Euro was overvalued against the U.S. dollar by approximately 15%.