In Windsor, Ontario, a Big Mac from McDonald’s costs C$4.19 (Canadian dollars),

Question

In Windsor, Ontario, a Big Mac from McDonald’s costs C$4.19 (Canadian dollars), and across the border in Detroit it costs $3.60 in U.S. dollars.

a. Suppose the nominal U.S. exchange rate with Canada is US$0.78 per Canadian dollar. Does purchasing power parity hold between the two countries?

b. What is the purchasing power parity exchange rate for the U.S.?

     Instructions: Round your answer to three decimal places.

     $ __ U.S. dollar per Canadian dollar.

No, it does not hold because the Canadian Big Mac costs more in terms of U.S. dollars. Yes, it holds because the Canadian Big Mac costs less in terms of U.S. dollars. Yes, it holds because the Canadian Big Mac costs more in terms of U.S. dollars. No, it does not hold because the Canadian Big Mac costs less in terms of U.S. dollars.

Explanation / Answer

(a) Option (2)

Price of Canadian big mac in US dollars = C4.19 x US$0.78 = US$3.27 < US$3.60

Since price of Canadian big Mac costs less, purchasing power parity does not hold.

(b) PPP exchange rate = US$3.6 / C$4.19 = US$0.859 per C$

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