The Economist magazine uses the price of a Big Mac to determine whether a curren

Question

The Economist magazine uses the price of a Big Mac to determine whether a currency is undervalued or overvalued. In July 2010, the price of a Big Mac was $3.73 in New York, 13.2 yuan in Beijing, and 6.50 Swiss francs in Geneva. The exchanges rates were 6.78 yuan per U.S. dollar and 1.05 Swiss francs per U.S. dollar.

a.Was the yuan undervalued or overvalued relative to purchasing power parity?

b. Was the Swiss franc undervalued or overvalued relative to purchasing power parity?

c. What is purchasing power parity and what happens when this condition doesn’t hold?

d Do you think the price of a Big Mac in different countries provides a valid test of purchasing power parity?

Explanation / Answer

price of Mac in china = 13.2yuan= $13.2/6.78=$1.95

price of Mac in france = 6.50SF= $6.50/1.05= $6.19

a.yuan was undervalued based on ppt

b. Swiss Franc was overvalued on the basis of PPT

c. Purchasing power parity is defined as the ratio of foreign price to the domestic price. It compares different country currencies through market of basket of goods.

When purchasing power parity does not hold it leads to undervaluation and overvaluation of currency in world market accordingly the trade and capital market gets affected.

d. No I don't think the price of a big Mac in different countries provide a valid test of purchasing power parity it is because the purchasing power parity relies on the presence of arbitrage opportunities . it is a kind of opportunity in which the goods are bought at less price in a country and is sold at Higher price in other country .

thanx

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