Suppose that the price of a Big Mac is a good approximation of the price level in the country. A Big Mac costs £2 in London and $3 in New York
a) If purchasing power parity holds, what is the exchange rate between the U.S. dollar and the British pound?
b) If the current exchange rate is $1.6 per pound, what is the dollar price of a Big Mac in London? What do you predict will happen to the exchange rate? Explain.
c) The exchange rate between the U.S. dollar and the Russian ruble is 30 rubles per dollar. If purchasing power parity holds, what is the price of a Big Mac in Moscow?
a) If purchasing power parity holds, the dollar price of a Big Mac in London must be the same as that in New York. This is the case when the exchange rate is $1.5 per pound. With this exchange rate, the dollar price of a Big Mac in London is £2 × 1.5 dollars per pound = $3.
b) If the current exchange rate is $1.6 per pound, the dollar price of a Big Mac in London is
£2 × 1.6 dollars per pound, which is $3.20. If the price of a Big Mac represents the price level in the country, British goods are relatively more expensive than American goods. The quantity of the U.K. imports demanded decreases in the United States and the quantity of U.S. exports demanded increases in the United Kingdom. The demand for dollars in the foreign exchange market increases and the demand for pounds decreases. As a result, the dollar appreciates against the pound until the purchasing-power-parity exchange rate is restored.
c) If purchasing power parity holds, the dollar price of a Big Mac in Moscow must be the same as in New York, that is, $3. Given the ruble/dollar exchange rate, the price of a Big Mac in Moscow is $3 × 30 rubles per dollar, which is 90 rubles.
You might also like to view...
The value of leisure time is
A) included in GDP and, in recent years, has become an increasing large part of GDP. B) excluded from GDP. C) zero. D) directly included in GDP but, in recent years, has become a decreasing large part of GDP. E) directly included in GDP and, in recent years, has not changed much as a fraction of GDP.
According to PPP, the real exchange rate between two countries will always equal
A) 0.0. B) 0.5. C) 1.0. D) 1.5.
Which of the following attributes of the recession of 2008-2009 is most supportive of the Keynesian view that the crowding-out effect will be minimal during a severe recession?
a. the immediate increase in output and employment generated by the budget deficits of 2008-2009 b. the decline in the general level of prices during 2009 c. short-term interest rates falling to near zero, despite growing budget deficits during 2008-2009 d. short-term interest rates falling to near zero, as the budget deficit declined during 2008-2009
A kink in the demand curve facing an oligopolist is caused by:
A. rapidly rising marginal revenues. B. excessive advertising. C. the belief that competitors will follow price increases but not match price decreases. D. the tendency of competitors to follow price reductions but not price increases.